Accounting Scandal Updates and Other Fraud Between October 1 and December 31, 2010
Bob Jensen at
Trinity University

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

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

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

Other Documents

Richard Campbell notes a nice white collar crime blog edited by some law professors --- http://lawprofessors.typepad.com/whitecollarcrime_blog/ 

To date Nadine has eight modules on accounting fraud plus more modules on other types of fraud
A woman known as "Fraud Girl" ran a series of weekly columns in Simoleon Sense. Now Fraud Girl has her own blog called Sleight of Hand ---
 http://sleightfraud.blogspot.com/
Her real name is Nadine Sebai
Now I have two women to stalk in Chicago ---
Francine --- http://retheauditors.com/ 
Nadine  ---  http://sleightfraud.blogspot.com/

Nadine's accounting modules to date --- http://sleightfraud.blogspot.com/search/label/Accounting

Bob Jensen's threads on accounting education blogs ---
http://www.trinity.edu/rjensen/ListservRoles.htm

"SEC Whistleblower Fund Totals $450 Million," Huffington Post, October 29, 2010 ---
http://www.huffingtonpost.com/2010/10/29/sec-whistleblower-fund-450-million_n_776397.html

The Securities and Exchange Commission says it has set aside about $450 million for payments to outside whistleblowers whose information results in successful cases and penalties collected from companies or individuals.

The SEC set up the program in accordance with the financial overhaul law enacted in July. It follows intense public criticism of the agency for the breakdown that allowed Bernard Madoff's multibillion-dollar fraud to go undetected for 16 years, despite numerous red flags raised by whistleblowers.

A report issued Friday by the SEC shows it has put $451.9 million into a new fund to pay whistleblowers, which must have a minimum $300 million.

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

 



  • Book:  Auditing Real-World Frauds: A Practical Case Application Approach
    Lynda M. Dennis, Ph.D., CPA, CGFO
    Publisher: AICPA for CPE Self-Study
    Price:  $174 discounted to $139 for AICPA members


    "Mayer Hoffman McCann Blows a Bunch of Hot GAAS (And a Serious Audit) ," Los Angeles Times via Jr. Deputy Accountant, December 22, 2010 ---
    http://www.jrdeputyaccountant.com/2010/12/mayer-hoffman-mccann-blows-bunch-of-hot.html


    Laugh of the Day (if some attorneys weren't making money on this)
    Who is suing the SEC for $3.87 trillion of taxpayer money?
    http://www.jrdeputyaccountant.com/2010/12/cmkm-greatest-financial-statements-weve.html


    "FBI says cyber-thieves stole $70 million," MIT's Technology Review, October 1, 2010 ---
    http://www.technologyreview.com/wire/26454/?nlid=3583&a=f

    The FBI and law enforcement agencies in Ukraine, the Netherlands and Britain are tracking down international cyber criminals who stole $70 million by using malware that captured passwords and account numbers to log onto online bank accounts.

    At a press briefing Friday, the FBI said Operation Trident Breach began in May 2009 when agents in Omaha, Neb., were alerted to some of the stolen money, which was flowing in bulk payments to 46 bank accounts around the United States.

    Ukrainian authorities have detained five people thought to have participated in some of the thefts and Ukraine has executed eight search warrants in the ongoing investigation.

    Gordon Snow, the FBI's assistant director in charge of the cyber division, said police agencies overseas were instrumental in finding criminals who designed the malicious software, others who used it and still others called "money mules," who transferred the stolen funds to havens as distant as Hong Kong, Singapore and Cyprus.

    Many of the victims were small- and medium-sized businesses that don't have the money to invest in high-level computer security.

    On Thursday, 37 people were charged in papers unsealed in federal court in Manhattan with conspiracy to commit bank fraud, money laundering, false identification use and passport fraud for their roles in the invasion of dozens of victims' accounts. Fifty-five have been charged in state court in Manhattan.

    The FBI said the software was known as an Internet banking Trojan, which can steal computer access data including usernames and passwords for bank accounts, e-mail accounts and social-networking websites. The program would gain access to the computer when a victim clicked on a link or opened a file attached to a seemingly legitimate e-mail message.

     


    Federal Bureau of Investigation: White Collar Crime and Fraud (FBI, History) --- http://www.fbi.gov/whitecollarcrime.htm

    Also see the FBI Complaint Center  --- http://www.ic3.gov/default.aspx

    Bob Jensen's threads on fraud reporting ---
    http://www.trinity.edu/rjensen/FraudReporting.htm


    Someone in KPMG is keeping tab on the street price of fake goods all across the world ---
    http://www.big4.com/blog/if-you-are-buying-fake-goods-in-london-its-a-real-ripoff-says-kpmg-656


    Questions
    Do your students know the difference between mutual funds and hedge funds?
    Do your students really understand how Ponzi schemes work?
    Start with (gasp) Wikipedia.

    The Worst Sack Ever on John Elway (former All-Pro Quarterback in the Mile-High City)
    Elway Got Schemered!
    Stanford Graduates Should Know Better
    "John Elway Invested $15 MILLION With Alleged Ponzi Schemer," Huffington Post, October 14, 2010 ---
    http://www.huffingtonpost.com/2010/10/14/john-elway-invested-15-mi_n_762663.html

    John Elway Invested $15 MILLION With Alleged Ponzi Schemer

    diggfacebook Twitter stumble reddit del.ico.us What's Your Reaction? .Amazing Inspiring Funny Scary Hot Crazy Important Weird Read More: Elway 15 Million, John Elway, Mitchell Pierce, Ponzi Scheme, Sean Michael Mueller, Sean Mueller, Denver News 10 views Get Denver Alerts Email Comments 17 DENVER — Former Denver Broncos quarterback John Elway and his business partner gave $15 million to a hedge-fund manager now accused of running a Ponzi scheme.

    The Denver Post reported Thursday that Elway and Mitchell Pierce filed a motion saying they wired the money to Sean Michael Mueller in March. They said Mueller agreed to hold the money in trust until they agreed on where it would be invested.

    A state investigator says 65 people invested $71 million with Mueller's company over 10 years and it only had $9.5 million in assets in April and $45 million in liabilities.

    Elway's filing asks that the court put their claims ahead of others so they can collect their money first. His lawyer declined to comment.

    Jensen Comment
    It's hard to feel sorry for rich people who play in games without rules (hedge funds)
    Better to play in games with rules and stand behind 325 lb linemen with missing teeth, BO, and noses that look like corkscrews.

    Bob Jensen's threads on Hedge Funds are under the H-term at
    http://www.trinity.edu/rjensen/acct5341/speakers/133glosf.htm
    Note that hedge funds may have nothing to do with hedging.

    Bob Jensen's threads on Ponzi schemes are at
    http://www.trinity.edu/rjensen/FraudRotten.htm#Ponzi

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


    Breaking a Vow of Poverty in a Big Way
    "Nun Is Arrested for Allegedly Stealing $1.2-Million From Iona College," by Andrea Fuller, Chronicle of Higher Education, December9, 2010 ---
    http://chronicle.com/article/Nun-Is-Arrested-for-Allegedly/125678/

    Bob Jensen's Fraud Updates are at
    http://chronicle.com/article/Nun-Is-Arrested-for-Allegedly/125678/


    When does "questionable management" become fraud?
    Raising university funds to privately publish a professor's book?
    "UVa Audit Finds 'Questionable' Management by Journal Editor," by Robin Wilson, Chronicle of Higher Education, October 20, 2010 ---
    http://chronicle.com/article/UVa-Audit-Finds-Questionable/125034/

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


    "In Fraud the Big Boys Walk Free," by Via Zamansky & Associates, Sleight of Hand Blog, December 15, 2010 ---
    http://sleightfraud.blogspot.com/2010/12/in-fraud-big-boys-walk-free.html

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


    From The Wall Street Journal Accounting Weekly Review on October 14, 2010

    Rogue French Trader Sentenced to 3 Years
    by: David Gauthier-Villars
    Oct 06, 2010
    Click here to view the full article on WSJ.com


    TOPICS: Banking, Internal Auditing, Internal Controls, International Auditing
    SUMMARY: Judge Dominique Plauthe heard the case against Jérôme Kerviel, the French bank trader who amassed €4.9 billion in losses, equal to $7.2 billion, by making huge unauthorized trades that he hid for months until discovery in January 2008. Many had expected that Société Générale would have taken some of the blame for these losses. The bank "...itself acknowledged in 2008 that it didn't have the right control systems in place to correctly surpervise Mr. Kerviel." His lawyers argued "...that Société Générale turned a blind eye on his illicit behavior as long as he was making money." But Judge Plauthe "pointed his finger entirely at Mr. Kerviel, calling him 'the unique mastermind, initiator and operator of a fraudulent system.'"Mr. Kerviel has been sentenced to three years in prison and ordered to repay his former employer the €4.9 billion-a sum impossible for him to ever repay. Société Générale has said it will not ask Mr. Kerviel "...to give up salary, savings, or assets...[but] would, however, seek any revenue 'derived from the fraud,' including money Mr,. Kerviel made on his book 'Caught in a Downward Spiral'."
    CLASSROOM APPLICATION: This case illustrates the need for tight internal controls to prevent unauthorized activity causing substantial losses. It also makes clear that it is difficult to detect fraud when a perpetrator is intent on covering it
    QUESTIONS:
    1. (Introductory) How did a lone trader wrack up huge losses for the French bank Société Générale?

    2. (Introductory) How did M. Kerviel cover up his activities?

    3. (Advanced) What types of controls are designed to detect the steps that M. Kerviel took to commit unauthorized trading?

    4. (Advanced) Why would a bank be concerned about the fact that it "missed a € 1.4 billion gain" as well as the huge losses?

    Reviewed By: Judy Beckman, University of Rhode Island

    RELATED ARTICLES:
    French Bank Rocked by Rogue Trader
    by David Gauthier-Villars, Carrick Mollenkamp and Alistair MacDonald
    Jan 25, 2008
    Page: A1

    "Rogue French Trader Sentenced to 3 Years Kerviel Is Ordered to Repay Société Générale $6.7 Billion," by by: David Gauthier-Villars, The Wall Street Journal, October 6, 2010 ---
    http://online.wsj.com/article/SB10001424052748703726404575533392217262322.html?mod=djem_jiewr_AC_domainid

    A French court sentenced former Société Générale trader Jérôme Kerviel to three years in prison for his role in one of the world's biggest-ever trading scandals and ordered him to repay his former employer €4.9 billion ($6.71 billion)—a sum it would take him 180,000 years to pay at his current salary.

    Mr. Kerviel's lawyer announced he is filing an appeal that will likely take another 18 months to work through the courts. Societe Generale's attorney said the bank would not actually expect the former trader—who now works for a computer-consulting firm—to reimburse the money or force him to give up his current paycheck or home.

    Still, the ruling is a welcome development for France's second-largest bank, as it lays the entire blame of the 2008 trading debacle on Mr. Kerviel. For years, the low-level trader managed to hide risky trading, at one time making an unauthorized bet of €50 billion.

    Throughout the trial, Mr. Kerviel and his lawyers argued that Société Générale turned a blind eye on his illicit behavior as long as he was making money. Société Générale itself acknowledged in 2008 that it didn't have the right control systems in place to correctly supervise Mr. Kerviel. For this lack of oversight, the bank has already paid €4 million in fines to France's banking regulator.

    Though Société Générale wasn't a defendant in the trial, many had expected the court to pin some of the responsibility on the bank.

    Judge Dominique Pauthe, however, pointed his finger entirely at Mr. Kerviel, calling him "the unique mastermind, initiator and operator of a fraudulent system."

    In convicting Mr. Kerviel of breach of trust, forgery, and unauthorized computer use, the judge also handed Mr. Kerviel a lifetime trading ban. The prison sentence handed to Mr Kerviel is for five years, of which two years were suspended.

    As the judge read the ruling before a packed court, Mr. Kerviel sat impassive. "Jerome is disgusted," his lawyer, Olivier Metzner later told reporters.

    "This ruling says the bank is responsible of nothing and that Jerome Kerviel is responsible for the excesses of the banking system."

    For Société Générale, the ruling is likely to help bank executives' efforts to draw a line under the scandal and clean up its image. The bank's management team has changed since the scandal, and new control systems have been introduced to its trading floors.

    The bank's lawyer, Jean Veil, said that even if the verdict were to be upheld on appeal, Société Générale wouldn't ask Mr. Kerviel to give up salary, savings or assets. The bank would, however, seek any revenue "derived from the fraud," including money Mr. Kerviel made on his book "Caught in a Downward Spiral," which chronicles the affair, Mr. Veil said. Mr. Kerviel sold about 50,000 copies of his book at €19.90 apiece, according to his French publisher Flammarion.

    Outside the courtroom, many French analysts and politicians criticized the verdict, saying Mr. Kerviel had been made a scapegoat at a time when the banking system is trying to atone for its role in the global financial crisis.

    "Mr. Kerviel only did what he was paid for: speculate," Pierre Laurent, head of France's Communist Party said in a statement. "He was a cog in a machine and his guilt cannot be detached from the whole system."

    In January 2008, Société Générale shocked world markets when it disclosed it had suffered a net loss of €4.9 billion after unwinding a series of wild bets placed by Mr. Kerviel. As the probe got under way, Mr. Kerviel immediately acknowledged to engaging in years of unauthorized trades, but said that he was just trying to make money for the bank.

    Over the years, Mr. Kerviel had been able to defeat multiple layers of control at the bank using apparently simple techniques: He fabricated emails, promised bottles of champagne to back-office supervisors and gave evasive answers when questioned about anomalies in his trading books.

    During the trial, Mr. Kerviel argued that the vague nature of his answers should have alerted supervisors. But the court said Mr. Kerviel couldn't blame others.

    Continued in article

    Jensen Comment
    This is a blatant illustration of how lightly white collar criminals are let off relative to other criminals. It seems to me that, aside from violent crimes, punishments should be doled out on the basis of the amount stolen ---
    http://www.trinity.edu/rjensen/FraudConclusion.htm#CrimePays

    From Bob Jensen's archives
    Société Générale Tradung Fraud in France

    Jérôme Kerviel's duties included arbitraging equity derivatives and equity cash prices and commenced a crescendo of fake trades. This is an interesting fraud case to study, but I doubt whether auditors themselves can be credited with discovery of the fraud. It is a case of poor internal controls, but there are all sorts of suggestions that the bank was actually using Kerviel to cover its own massive losses. Kerviel did not personally profit from his fraud, although he may have been anticipating a bonus due to his "profitable" fake-trade arbitraging.

    Société Générale --- http://en.wikipedia.org/wiki/Soci%C3%A9t%C3%A9_G%C3%A9n%C3%A9rale

    On January 24, 2008, the bank announced that a single futures trader at the bank had fraudulently lost the bank €4.9billion (an equivalent of $7.2billionUS), the largest such loss in history. The company did not name the trader, but other sources identified him as Jérôme Kerviel, a relatively junior futures trader who allegedly orchestrated a series of bogus transactions that spiraled out of control amid turbulent markets in 2007 and early 2008.

    Partly due to the loss, that same day two credit rating agencies reduced the bank's long term debt ratings: from AA to AA- by Fitch; and from Aa1/B to Aa2/B- by Moody's (B and B- indicate the bank's financial strength ratings).

    Executives said the trader acted alone and that he may not have benefited directly from the fraudulent deals. The bank announced it will be immediately seeking 5.5 billion euros in financing. On the eve and afternoon of January 25, 2008, Police raided the Paris headquarters of Société Générale and Kerviel's apartment in the western suburb of Neuilly, to seize his computer files. French presidential aide Raymond Soubie stated that Kerviel dealt with $73.3 billion (more than the bank's market capitalization of $52.6 billion). Three union officials of Société Générale employees said Kerviel had family problems. On January 26, 2008, the Paris prosecutors' office stated that Jerome Kerviel, 31, in Paris, "is not on the run. He will be questioned at the appropriate time, as soon as the police have analysed documents provided by Société Générale." Kerviel was placed under custody but he can be detained for 24 hours (under French law, with 24 hour extension upon prosecutors' request). Spiegel-Online stated that he may have lost 2.8 billion dollars on 140,000 contracts earlier negotiated due to DAX falling 600 points.

    The alleged fraud was much larger than the transactions by Nick Leeson that brought down Barings Bank

    Main article: January 2008 Société Générale trading loss incident

    Other notable trading losses

    ·         Yasuo Hamanaka caused a loss of about $2.6 billion, over ten years, in unauthorized copper trading on the London Metal Exchange

    ·         Nick Leeson caused a loss of £827 million for Barings Bank, leading to its collapse

    ·         List of trading losses

     

    April 10 message from Jagdish Gangolly [gangolly@GMAIL.COM]

    Francine,

    1. In France, accountants and auditors are regulated by different ministries; accountants by Ministry of Finance, and auditors by the Ministry of Justice. Only auditors can perform statutory audits. All auditors are accountants, but not necessarily the other way round.

    I am not sure there is a fundamental difference when it comes to apportionment of blame and so on, except that the ominous and heavy hand of the state pervades in France; even the codes assigned to the items in the national chart  of accounts is specified in French law (in the so called Accounting Plan).

    2. I do not think the accountants/auditors were involved in the Societe Generale case. The unauthorised trades were detected and the positions closed all within two days or so. Unfortunately us US taxpayers were left holding the  bag in the long run; we paid $11 billion for the credit default swaps to SG.

    Jagdish

    --
    Jagdish S. Gangolly
    Department of Informatics
    College of Computing & Information
    State University of New York at Albany
    Harriman Campus, Building 7A, Suite 220
    Albany, NY 12222
    Phone: 518-956-8251, Fax: 518-956-8247

     

    April 11, 2010 reply from Francine McKenna [retheauditors@GMAIL.COM]

    Societe Generale was not resolved that quickly. In the MF Global "rogue trading scandal" the positions were closed overnights because the trades were in wheat which is exchange traded and cleared by the CME. Societe General trader was working with primarily non-exchange traded derivatives. They did not see it right away and counterparties who could complain about margin calls did not exist.

    The banks internal audit group was ignored (like AIG) and the auditors gave a bank that had poor internal controls and the ability for any controls to be overridden easily, a clean bill of health.

    Thanks for further clarification of the French approach.  I did not know they had accountants and auditors but that makes it seem even more like the barristers and solicitors division...

    http://retheauditors.com/2008/10/14/what-the-auditors-saw-an-update-on-societe-generale/

    http://retheauditors.com/2008/03/03/mf-global-socgen-and-rogue-traders-dont-fall-for-the-simple-answers/

    April 11, 2010 reply from Tom Selling [tom.selling@GROVESITE.COM]

    To refresh memories, the auditors (two Big Four firms) of Société Générale were involved in the aftermath, by exploiting a questionable loophole in IFRS. Société Générale chose to lump Kerviel's 2008 trading losses in 2007's income statement, thus netting the losses of the later year with his gains of the previous year. There is no disputing that the losses occurred in 2008, yet the company's position is that application of specific IFRS rules (very simply, marking derivatives to market) would, for reasons unstated, result in a failure of the financial statements to present a "true and fair view."

    See Floyd Norris’s column in NYT:

    http://www.nytimes.com/2008/03/07/business/07norris.html?ref=business 

    Best,
    Tom

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


    "E-Mail is the Big Security Culprit," by Jerry Trites, IS Assurance Blog, December 10, 2010 ---
    http://uwcisa-assurance.blogspot.com/

    A new report from software vendor Awareness Technologies points to personal email services like Gmail, Hotmail and Yahoo Mail as being "increasingly responsible for the accidental or deliberate loss of customer and corporate data."

    Some companies ban such personal email services, but many do not. These services are all web based, and subject to a high degree of pressure from hackers, who have developed techniques to capture login IDs and passwords and then go in and seize the data either in the body of the messages or in attachments to them.

    The findings resulted from a survey of data breaches at more than 10,000 sites. The survey also indicated that most of the data breaches could be traced back to the fault of employees, who were either poorly trained or gullible enough to fall for phishing expeditions.

    One approach is to ban the use of personal email services on corporate computers, but this doesn't work well in today's environment since many employees mix their personal and business accounts. In addition, they often use their own personal computers or other devices for business purposes, and this is a growing trend.

    Another approach is to embrace the use of personal email services and train the employees in their proper use and awareness of the threats that exist.

    Since breaches arising from personal email services now outnumber those arising from the abuse of USB ports, previously the leader, email controls are more important than ever before.


    For a report on the Survey, please check out this link.

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


    "New York Court of Appeals Stands By Corporate Man: In Pari Delicto Prevails," by Francine McKenna, re:TheAuditors, October 22, 2010 ---
    http://retheauditors.com/2010/10/22/new-york-court-of-appeals-stands-by-corporate-man-in-pari-delicto-prevails/

    The New York Court of Appeals decided on October 21, 2010, by a vote of 4-3, to “decline to alter our precedent relating to in pari delicto and imputation and the adverse interest exception, as we would have to do to bring about the expansion of third-party liability sought by plaintiffs here.”

     

    The decision is flawed, misguided and strongly biased towards corporate interests rather than shareholder and investor interests. Imputationa fundamental principle that has outlived its usefulness and that defies common sense and fairness – has been reaffirmed in cases of third-party advisor negligence or collusion.

    “A fraud that by its nature will benefit the corporation is not “adverse” to the corporation’s interests, even if it was actually motivated by the agent’s desire for personal gain (Price, 62 NY at 384). Thus, “[s]hould the ‘agent act[] both for himself and for the principal,’ . . . application of the [adverse interest] exception would be precluded” (Capital Wireless Corp. v Deloitte & Touche, 216 AD2d 663, 666 [3d Dept 1995] [quoting Matter of Crazy Eddie Sec. Litig., 802 F Supp 804, 817 (EDNY 1992)]; see also Center, 66 NY2d at 785 [the adverse interest exception "cannot be invoked merely because . . . .(the agent) is not acting primarily for his principal"]). [*12]

    New York law thus articulates the adverse interest exception in a way that is consistent with fundamental principles of agency. To allow a corporation to avoid the consequences of corporate acts simply because an employee performed them with his personal profit in mind would enable the corporation to disclaim, at its convenience, virtually every act its officers undertake. “[C]orporate officers, even in the most upright enterprises, can always be said, in some meaningful sense, to act for their own interests” (Grede v McGladrey & Pullen LLP, 421 BR 879, 886 [ND Ill 2008]). A corporate insider’s personal interests — as an officer, employee, or shareholder of the company — are often deliberately aligned with the corporation’s interests by way of, for example, stock options or bonuses, the value of which depends upon the corporation’s financial performance.

    And this is ok?

    A majority of the New York Court of Appeals bought the self-serving, selfish and unjust arguments of the defendants and their flunky amicus brief toadies supporting criminal corporate fraudsters and, get this, the shareholders of the accounting firms (!!). The New York Court of Appeals abandoned the shareholders and creditors of Refco and AIG for criminals and incompetents.

    I could not have imagined more contemptible excuses for judicial cowardice if I were writing this decision for a novel of corporate cronyism to the extreme in a Utopian nirvana for capitalist parasites.

    “In particular, why should the interests of innocent stakeholders of corporate fraudsters trump those of innocent stakeholders of the outside professionals who are the defendants in these cases?

    …In a sense, plaintiffs’ proposals may be viewed as creating a double standard whereby the innocent stakeholders of the corporation’s outside professionals are held responsible for the sins of their errant agents while the innocent stakeholders of the corporation itself are not charged with knowledge of their wrongdoing agents. And, of course, the corporation’s agents [*19]would almost invariably play the dominant role in the fraud and therefore would be more culpable than the outside professional’s agents who allegedly aided and abetted the insiders or did not detect the fraud at all or soon enough. The owners and creditors of KPMG and PwC may be said to be at least as “innocent” as Refco’s unsecured creditors and AIG’s stockholders.

    The doctrine’s full name is in pari delicto potior est conditio defendentis, meaning “in a case of equal or mutual fault, the position of the [defending party] is the better one” (Baena, 453 F3d at 6 n 5 [internal quotation marks omitted]).

    I have some other names for it:

    • Immunity from Prosecution for the “Duped” theory
    • Incompetent Professional service providers Defense
    • Invocation of Plausible Deniability doctrine

    Continued in article

    Bob Jensen's threads on legal issues and professionalism are at
    http://www.trinity.edu/rjensen/Fraud001.htm


    "The Shadow Scholar:  The man who writes your students' papers tells his story," by Ed Dante, Chronicle of Higher Education, November 12, 2010 ---
    http://chronicle.com/article/The-Shadow-Scholar/125329/

    November 15, 2010 reply from Bob Jensen

    Hi David,

    Thanks for this interesting link.

    This cheat cannot be an expert on everything without becoming a very good plagiarist, and even then he probably does not have a clue about specialty topics that can be plagiarized. My guess is that he's never heard of XBRL, FAS 138, IAS 9, FIN 48, or FAS 157. So as long as you stick to tough and narrow topics, chances are he will refuse offers to write on such technical topics.

    Our worry is that when he or she retires from ghost writing, this cheat will form a sizable company comprised of technical experts that can write/plagiarize on many more specialized topics.

    If fact it leads me to wonder how many students today are bypassing this cheat and are simply cutting and pasting from some of my documents at http://www.trinity.edu/rjensen/threads.htm 

    Thanks,

    Bob

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


    It's About Time
    "Settlement Reached in Essay-Mill Lawsuit." by Paige Chapman, Chronicle of Higher Education, October 25, 2010 ---
    http://chronicle.com/blogs/wiredcampus/settlement-reached-in-essay-mill-lawsuit/27852?sid=wc&utm_source=wc&utm_medium=en

    Bob Jensen's threads about academic cheating ---
    http://www.trinity.edu/rjensen/Plagiarism.htm

    Questions
    Should a doctoral student be allowed to hire an editor to help write her dissertation? 
    If the answer is yes, should this also apply to any student writing a course project, take home exam, or term paper?

    Answer
    Forwarded by Aaron Konstam
    "Academic Frauds," The Chronicle of Higher Education, November 3, 2003 --- http://chronicle.com/jobs/2003/11/2003110301c.htm 

    Question (from "Honest John"): I'm a troubled member of a dissertation committee at Private U, where I'm not a regular faculty member (although I have a doctorate). "Bertha" is a "mature" student in chronological terms only. The scope of her dissertation research is ambiguous, and the quality of her proposal is substandard. The committee chair just told me that Bertha is hiring an editor to "assist" her in writing her dissertation. I'm outraged. I've complained to the chair and the director of doctoral studies, but if Bertha is allowed to continue having an "editor" to do her dissertation, shouldn't I report the university to an accreditation agency? This is too big a violation of integrity for me to walk away.

    Answer: Ms. Mentor shares your outrage -- but first, on behalf of Bertha, who has been betrayed by her advisers.

    In past generations, the model of a modern academician was a whiz-kid nerd, who zoomed through classes and degrees, never left school, and scored his Ph.D. at 28 or so. (Nietzsche was a full professor at 24.) Bertha is more typical today. She's had another life first.

    Most likely she's been a mom and perhaps a blue-collar worker -- so she knows about economics, time management, and child development. Maybe she's been a musician, a technician, or a mogul -- and now wants to mentor others, pass on what she's known. Ms. Mentor hears from many Berthas.

    Returning adult students are brave. "Phil" found that young students called him "the old dude" and snorted when he spoke in class. "Barbara" spent a semester feuding with three frat boys after she told them to "stop clowning around. I'm paying good money for this course." And "Millie's" sister couldn't understand her thirst for knowledge: "Isn't your husband rich enough so you can just stay home and enjoy yourself?"

    Some tasks, Ms. Mentor admits, are easier for the young -- pole-vaulting, for instance, and pregnancy. Writing a memoir is easier when one is old. And no one under 35, she has come to suspect, should give anyone advice about anything. But Bertha's problem is more about academic skills than age.

    Her dissertation plan may be too ambitious, and her writing may be rusty -- but it's her committee's job to help her. All dissertation writers have to learn to narrow and clarify their topics and pace themselves. That is part of the intellectual discipline. Dissertation writers learn that theirs needn't be the definitive word, just the completed one, for a Ph.D. is the equivalent of a union card -- an entree to the profession.

    But instead of teaching Bertha what she needs to know, her committee (except for Honest John) seems willing to let her hire a ghost writer.

    Ms. Mentor wonders why. Do they see themselves as judges and credential-granters, but not teachers? Ms. Mentor will concede that not everyone is a writing genius: Academic jargon and clunky sentences do give her twitching fits. But while not everyone has a flair, every academic must write correct, clear, serviceable prose for memos, syllabuses, e-mail messages, reports, grant proposals, articles, and books.

    Being an academic means learning to be an academic writer -- but Bertha's committee is unloading her onto a hired editor, at her own expense. Instead of birthing her own dissertation, she's getting a surrogate. Ms. Mentor feels the whole process is fraudulent and shameful.

    What to do?

    Ms.Mentor suggests that Honest John talk with Bertha about what a dissertation truly involves. (He may include Ms. Mentor's column on "Should You Aim to Be a Professor?") No one seems to have told Bertha that it is an individual's search for a small corner of truth and that it should teach her how to organize and write up her findings.

    Moreover, Bertha may not know the facts of the job market in her field. If she aims to be a professor but is a mediocre writer, her chances of being hired and tenured -- especially if there's age discrimination -- may be practically nil. There are better investments.

    But if Bertha insists on keeping her editor, and her committee and the director of doctoral studies all collude in allowing this academic fraud to take place, what should Honest John do?

    He should resign from the committee, Ms. Mentor believes: Why spend his energies with dishonest people? He will have exhausted "internal remedies" -- ways to complain within the university -- and it is a melancholy truth that most bureaucracies prefer coverups to confrontations. If there are no channels to go through, Honest John may as well create his own -- by contacting the accrediting agencies, professional organizations in the field, and anyone else who might be interested.

    Continued in the article.

    November 3, 2003 reply from David R. Fordham [fordhadr@JMU.EDU

    Bob, there are two very different questions being addressed here.

    The first deals with the revelation that “her dissertation research is ambiguous, and the quality of her proposal is substandard”.

    The editing of a manuscript is a completely different issue.

    The ambiguity of the research and the flaws with the proposal should be addressed far more forcefully than the editing issue!

    Care should be used to ensure that the editor simply edits (corrects grammar, tense, case, person, etc.), and isn’t responsible for the creation of ideas. But if the editor is a professional editor who understands the scope of his/her job, I don’t see why editing should be an issue for anyone, unless the purpose of the dissertation exercise is to evaluate the person’s mastery of the minutiae of the English language (in which case the editor is indeed inappropriate).

    Talk about picking your battles … I’d be a lot more upset about ambiguous research than whether someone corrected her sentence structure. I believe the whistle-blower needs to take a closer look at his/her priorities. A flag needs to be raised, but about the more important of the two issues.

    David R. Fordham
    PBGH Faculty Fellow
    James Madison University

    The changing definition of "authorship" and possibly even "scholarship" in the digital age
    We haven't just opened up [Jane] Austen studies, we've pushed digital encoding further," Ms. Sutherland said. "I think we are giving good value because we're giving a resource that's [now] freely available online back to the public.
    Jennifer Howard, "Jane Austen's Well-Known Style Owed Much to Her Editor, Scholar Argues," Chronicle of Higher Education, October 22, 2010 ---
    http://chronicle.com/article/Jane-Austens-Well-Known-Style/125078/

    Bob Jensen's threads about assessment ---
    http://www.trinity.edu/rjensen/assess.htm


    "Why Do CFOs Become Involved in Material Accounting Manipulations?" Harvard Law School Forum, December 20, 2010 ---
    http://blogs.law.harvard.edu/corpgov/2010/12/20/why-do-cfos-become-involved-in-material-accounting-manipulations/

    In the paper, Why Do CFOs Become Involved in Material Accounting Manipulations? we investigate why CFOs become involved in material accounting manipulations. To address this research question, we examine two possible explanations. CFOs might instigate accounting manipulations for immediate personal financial gain, as reflected in their equity compensation. Alternatively, CFOs could manipulate the financial reports under pressure from CEOs.

    Using a comprehensive sample of material accounting manipulations disclosed between 1982 and 2005, we investigate the costs and benefits associated with intentional financial misreporting for CFOs. We find that CFOs bear substantial legal costs when involved in accounting manipulations. We also document that these CFO equity incentives (measured by pay-for-performance sensitivity) are not significantly different from those of CFOs of control firms. However, CEOs of the manipulation firms have significantly higher equity incentives and power than CEOs of the control firms. Moreover, CFO turnover is significantly higher within three years prior to the occurrences of material accounting manipulations for manipulation firms than control firms, consistent with CFOs facing significant costs (loss of job) for saying no to CEO pressure. Finally, our AAER content analyses suggest that CEOs of manipulation firms are more likely than CFOs to be described as having orchestrated the manipulation and to be requested to disgorge financial gains from the manipulation. Taken together, our findings suggest that CFOs are likely to become involved in material accounting manipulations because they succumb to CEO pressure, rather than because they seek immediate financial benefit.

    Some caveats are in order. First, we assume that CFOs of accounting manipulation firms are aware of or are involved in misreporting. We believe this assumption is reasonable given that one of the main job responsibilities of CFOs is to watch over the financial reporting process and make related decisions. However, in some unusual cases accounting manipulations could occur without the knowledge of CFOs (e.g., CEOs collude with divisional managers to create fictitious sales and hide the manipulation from CFOs). These cases are likely to add noise instead of introducing a systematic bias to our empirical results. Second, we assume that the companies identified by the SEC have indeed manipulated financial statements. This assumption seems reasonable given that the SEC spends effort and resources to establish evidence for the alleged manipulations. However, the SEC likely does not identify all the companies with accounting manipulations; as a result, some of our control firms might have “undetected” manipulations. This issue would be a concern if the SEC systematically pursues companies with characteristics examined and found significant in our empirical tests, but we are not aware of any evidence supporting this possibility.

    While subject to these caveats, our paper contributes to the understanding of CFOs’ incentives when they face accounting manipulation decisions. Our findings suggest that CFOs are typically not the instigator of accounting manipulations. Instead, it appears that CEOs, especially powerful CEOs with high equity incentives, exert significant influence over CFOs’ financial reporting decisions. In other words, CFOs’ role as watchdog over financial reports is compromised by the pressure from CEOs. Overall, the findings of this study suggest a corporate governance failure for the accounting manipulation firms, and have important implications for current corporate governance reform. While researchers, practitioners, and regulators have generally concluded that stock-based compensation has provided managers with incentives to misstate accounting numbers, our results indicate that re-designing compensation packages for CFOs is not necessarily the only remedy. Improving CFO independence by alleviating the pressure of CEOs on CFOs could be critical to improving financial reporting quality. One possible way to achieve this would be to have boards or audit committees more involved in CFO performance evaluation and in hiring and retention decisions (Matejka, 2007).

    The full paper is available for download here.---
    http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1260368 

    Bob Jensen's threads on creative accounting are at
    http://www.trinity.edu/rjensen/theory02.htm#Manipulation

    Also see
    http://www.trinity.edu/rjensen//theory/00overview/AccountingTricks.htm


    Question
    Where were the internal and external auditors for five years?

    From The Wall Street Journal Accounting Weekly Review on October 14, 2010 ---

    Hitachi Says Unit in Europe Fudged Sales for Five Years
    by: Hiroyuki Kachi
    Oct 06, 2010
    Click here to view the full article on WSJ.com

    TOPICS: Auditing, Fraudulent Financial Reporting, Internal Controls
    SUMMARY: "Hitachi Ltd. said...that one of its subsidiaries in Europe has been falsifying sales over the past five years, in the latest earnings-related scandal to highlight corporate-governance problems at large Japanese companies."


    CLASSROOM APPLICATION: Questions ask students to consider who is likely to have audited a German subsidiary of a Japanese parent that accounts for only 5% of total sales and to design audit tests over sales that would uncover the issues highlighted in the article.


    QUESTIONS:
    1. (Introductory) What is the relationship between Hitachi Ltd. Of Tokyo and Hitachi Power Tools Europe GmbH? Given this relationship, who do you think audited the accounts for the German Company?

    2. (Introductory) What is "window dressing"? Do you think that the problems described in the article fall into that category?

    3. (Advanced) Identify audit objectives for sales transactions related to the existence of sales, completeness of accounting for sales, and the timing of sales transactions.

    4. (Introductory) Refer to the audit objectives in answer to your question above. For which of these areas was internal control apparently weak and violated in the circumstances described in this article?

    5. (Introductory) Assume that you are the auditor for the German unit Hitachi Power Tools Europe GmbH. Design audit steps to assess the internal controls over sales transactions that you identify above.

    6. (Advanced) Is it possible that tests of internal controls would uncover no problems in this case of this German unit during this period that fictitious sales were recorded? Explain your answer.

    7. (Advanced) What substantive tests of account balances could uncover the problems identified in this article?

    8. (Introductory) The article states that the German unit contributes about 5% of total Hitachi sales and that the company "doesn't expect a significant impact on its bottom line from the scandal." Then why must Hitachi disclose this finding in its European operations?

    Reviewed By: Judy Beckman, University of Rhode Island

    "Hitachi Says Unit in Europe Fudged Sales for Five Years," by: Hiroyuki Kachi, The Wall Street Journal, October 06, 2010 ---
    http://online.wsj.com/article/SB10001424052748703726404575533651344959736.html?mod=djem_jiewr_AC_domainid

    Hitachi Ltd. said Tuesday that one of its subsidiaries in Europe has been falsifying sales over the past five years, in the latest earnings-related scandal to highlight corporate-governance problems at large Japanese companies.

    The Japanese electronics conglomerate said Hitachi Power Tools Europe GmbH, the German unit of power-tool maker Hitachi Koki Ltd., pursued questionable trading activities—such as booking fictitious sales and profits—between December 2005 and August 2010.

    Hitachi said it doesn't expect a significant impact on its bottom line from the scandal. Hitachi Koki said the improper transactions amounted to about 10 billion yen, or approximately $120 million at current rates, in sales between the fiscal year that ended in March 2006 and the first five months of the current fiscal year.

    Hitachi Koki's annual sales make up only a fraction of the parent company's earnings: 119.17 billion yen out of a group total of 8.969 trillion yen for the year ended in March.

    Although it is still clarifying the details, Hitachi Koki said the former president of the German subsidiary may have been trying to "window dress" the unit's earnings.

    The company said it dismissed the president on Monday. It didn't release the executive's name.

    In one case, the German unit bought back its products from clients after booking actual sales, while in another case the unit booked sales that didn't exist, Hitachi Koki said.

    Hitachi is one of Japan's largest companies by revenue, with more than 900 subsidiaries at the end of 2009, of which 542 were based overseas.

    The scandal suggests that Hitachi management in Japan might have difficulty in fully keeping track of the activities of its myriad units.

    Hitachi President Hiroaki Nakanishi earlier this year acknowledged that the company has too many subsidiaries, saying that it will have to be more selective in how it allocates its resources.

    The German unit contributes annual sales of approximately six billion yen to seven billion yen to Hitachi Koki's results, or about 5% of sales, Hitachi Koki said.

    Adjustments will be made to Hitachi Koki's earnings record to date, and won't cause any additional losses, the company said.

    Hitachi Koki said it has launched an investigation into the scandal, with a report due by the middle of October.

    In Tokyo, Hitachi's shares increased two yen to 360 yen, on a day when moves by Japan's central bank contributed to a 1.5% advance in the benchmark Nikkei Stock Average.

    Earlier this year, Mercian Corp., a unit of Kirin Holdings Co., was found to have inflated its profit by booking questionable transactions, a scandal that caused Kirin to make Mercian a wholly owned unit.

    Jensen Comment
    Currently Ernst & Young is the external auditor of Hitachi.

    Question
    Where were the internal and external auditors for five years?

    From The Wall Street Journal Accounting Weekly Review on October 14, 2010 ---

    Hitachi Says Unit in Europe Fudged Sales for Five Years
    by: Hiroyuki Kachi
    Oct 06, 2010
    Click here to view the full article on WSJ.com

    TOPICS: Auditing, Fraudulent Financial Reporting, Internal Controls
    SUMMARY: "Hitachi Ltd. said...that one of its subsidiaries in Europe has been falsifying sales over the past five years, in the latest earnings-related scandal to highlight corporate-governance problems at large Japanese companies."


    CLASSROOM APPLICATION: Questions ask students to consider who is likely to have audited a German subsidiary of a Japanese parent that accounts for only 5% of total sales and to design audit tests over sales that would uncover the issues highlighted in the article.


    QUESTIONS:
    1. (Introductory) What is the relationship between Hitachi Ltd. Of Tokyo and Hitachi Power Tools Europe GmbH? Given this relationship, who do you think audited the accounts for the German Company?

    2. (Introductory) What is "window dressing"? Do you think that the problems described in the article fall into that category?

    3. (Advanced) Identify audit objectives for sales transactions related to the existence of sales, completeness of accounting for sales, and the timing of sales transactions.

    4. (Introductory) Refer to the audit objectives in answer to your question above. For which of these areas was internal control apparently weak and violated in the circumstances described in this article?

    5. (Introductory) Assume that you are the auditor for the German unit Hitachi Power Tools Europe GmbH. Design audit steps to assess the internal controls over sales transactions that you identify above.

    6. (Advanced) Is it possible that tests of internal controls would uncover no problems in this case of this German unit during this period that fictitious sales were recorded? Explain your answer.

    7. (Advanced) What substantive tests of account balances could uncover the problems identified in this article?

    8. (Introductory) The article states that the German unit contributes about 5% of total Hitachi sales and that the company "doesn't expect a significant impact on its bottom line from the scandal." Then why must Hitachi disclose this finding in its European operations?

    Reviewed By: Judy Beckman, University of Rhode Island

    "Hitachi Says Unit in Europe Fudged Sales for Five Years," by: Hiroyuki Kachi, The Wall Street Journal, October 06, 2010 ---
    http://online.wsj.com/article/SB10001424052748703726404575533651344959736.html?mod=djem_jiewr_AC_domainid

    Hitachi Ltd. said Tuesday that one of its subsidiaries in Europe has been falsifying sales over the past five years, in the latest earnings-related scandal to highlight corporate-governance problems at large Japanese companies.

    The Japanese electronics conglomerate said Hitachi Power Tools Europe GmbH, the German unit of power-tool maker Hitachi Koki Ltd., pursued questionable trading activities—such as booking fictitious sales and profits—between December 2005 and August 2010.

    Hitachi said it doesn't expect a significant impact on its bottom line from the scandal. Hitachi Koki said the improper transactions amounted to about 10 billion yen, or approximately $120 million at current rates, in sales between the fiscal year that ended in March 2006 and the first five months of the current fiscal year.

    Hitachi Koki's annual sales make up only a fraction of the parent company's earnings: 119.17 billion yen out of a group total of 8.969 trillion yen for the year ended in March.

    Although it is still clarifying the details, Hitachi Koki said the former president of the German subsidiary may have been trying to "window dress" the unit's earnings.

    The company said it dismissed the president on Monday. It didn't release the executive's name.

    In one case, the German unit bought back its products from clients after booking actual sales, while in another case the unit booked sales that didn't exist, Hitachi Koki said.

    Hitachi is one of Japan's largest companies by revenue, with more than 900 subsidiaries at the end of 2009, of which 542 were based overseas.

    The scandal suggests that Hitachi management in Japan might have difficulty in fully keeping track of the activities of its myriad units.

    Hitachi President Hiroaki Nakanishi earlier this year acknowledged that the company has too many subsidiaries, saying that it will have to be more selective in how it allocates its resources.

    The German unit contributes annual sales of approximately six billion yen to seven billion yen to Hitachi Koki's results, or about 5% of sales, Hitachi Koki said.

    Adjustments will be made to Hitachi Koki's earnings record to date, and won't cause any additional losses, the company said.

    Hitachi Koki said it has launched an investigation into the scandal, with a report due by the middle of October.

    In Tokyo, Hitachi's shares increased two yen to 360 yen, on a day when moves by Japan's central bank contributed to a 1.5% advance in the benchmark Nikkei Stock Average.

    Earlier this year, Mercian Corp., a unit of Kirin Holdings Co., was found to have inflated its profit by booking questionable transactions, a scandal that caused Kirin to make Mercian a wholly owned unit.

    Jensen Comment
    Currently Ernst & Young is the external auditor of Hitachi. On June 29, 2010 the auditor's report contained the following:

     

    You can read more about Ernst & Young at
    http://www.trinity.edu/rjensen/Fraud001.htm
     


    "The Difficulty of Proving Financial Crimes," by Peter J. Henning, DealBook, December 13, 2010 ---
    http://blogs.law.harvard.edu/corpgov/2010/12/20/why-do-cfos-become-involved-in-material-accounting-manipulations/

    The prosecution revolved around the recognition of revenue from Network Associates’ sales of computer security products to a distributor through what is called “sell-in” accounting rather than the “sell-through” method. Leaving aside the accounting minutiae, prosecutors asserted that Mr. Goyal chose “sell-in” accounting as a means to overstate revenue from the sales and did not disclose complete information to the company’s auditors about agreements with the distributor that could affect the amount of revenue generated from the transactions.

    The line between aggressive accounting and fraud is a thin one, involving the application of unclear rules that require judgment calls that may turn out to be incorrect in hindsight. While Mr. Goyal was responsible as the chief financial officer for adopting an accounting method that likely enhanced Network Associates’ revenue, the problem with the securities fraud theory was that prosecutors did not introduce evidence that the “sell-in” method was improper under Generally Accepted Accounting Principles. And even if it was, the court pointed out lack of evidence that that this accounting method had a “material” impact on Network Associates’ revenue, which must be shown to prove fraud.

    A more significant problem for prosecutors was the absence of concrete proof that Mr. Goyal intended to defraud or that he sought to mislead the auditors. The Court of Appeals for the Ninth Circuit found that the “government’s failure to offer any evidence supporting even an inference of willful and knowing deception undermines its case.”

    The court rejected the proposition that an executive’s knowledge of accounting and desire to meet corporate revenue targets can be sufficient to establish the intent to commit a crime. The court stated, “If simply understanding accounting rules or optimizing a company’s performance were enough to establish scienter, then any action by a company’s chief financial officer that a juror could conclude in hindsight was false or misleading could subject him to fraud liability without regard to intent to deceive. That cannot be.”

    The court further explained that an executive’s compensation tied to the company’s performance does not prove fraud, stating that such “a general financial incentive merely reinforces Goyal’s preexisting duty to maximize NAI’s performance, and his seeking to meet expectations cannot be inherently probative of fraud.”

    Don’t be surprised to see the court’s statements about the limitations on corporate expertise and financial incentives as proof of intent quoted with regularity by defense lawyers for corporate executives being investigated for their conduct related to the financial meltdown. The opinion makes the point that just being at the scene of financial problems alone is not enough to show criminal intent.

    If the Justice Department decides to try to hold senior corporate executives responsible for suspected financial chicanery or misleading statements that contributed to the financial meltdown, the charges are likely to be similar to those brought against Mr. Goyal, requiring proof of intent to defraud and to mislead investors, auditors, or the S.E.C.

    The intent element of the crime is usually a matter of piecing together different tidbits of evidence, such as e-mails, internal memorandums, public statements and the recollection of participants who attended meetings. Connecting all those dots is not an easy task, as prosecutors learned in the case against two former Bear Stearns hedge fund managers when e-mails proved to be at best equivocal evidence of their intent to mislead investors, resulting in an acquittal on all counts.

    The collapse of Lehman Brothers raises issues about whether prosecutors could show criminal conduct by its executives. The bankruptcy examiner’s report highlighted the firm’s use of the so-called “Repo 105” transactions to make its balance sheet look healthier than it was each quarter, which could be the basis for criminal charges. But the appeals court opinion highlights how great the challenge would be to establish a Lehman executive’s knowledge of improper accounting or the falsity of statements because just arguing that a chief executive or chief financial officer had to be aware of the impact of the transactions would not be enough to prove the case.

    The same problems with proving a criminal case apply to other companies brought down during the financial crisis, like Fannie Mae, Freddie Mac and American International Group. Many of the decisions that led to these companies’ downfall were at least arguably judgment calls made with no intent to defraud, short-sighted as they might have been. Disclosures to regulators and auditors, and public statements to shareholders, are rarely couched in definitive terms, so proving that a statement was in fact false can be difficult, and then showing knowledge of its falsity even more daunting.

    In a concurring opinion in the Goyal case, Chief Judge Alex Kozinski bemoaned the use of the criminal law for this type of conduct, stating that this prosecution was “one of a string of recent cases in which courts have found that federal prosecutors overreached by trying to stretch criminal law beyond its proper bounds.”

    Despite the public’s desire to see some corporate executives sent to jail for their role in the financial meltdown, the courts will hold the government to the requirement of proof beyond a reasonable doubt and not simply allow the cry for retribution to lead to convictions based on high compensation and presiding over a company that sustained significant losses.

    Continued in article

    The State of New York's filing against Ernst & Young ---
    http://goingconcern.com/2010/12/lunchtime-reading-the-complaint-against-ernst-young/#more-23070

    Bob Jensen's threads on Lehman's Repo 105/108 transactions are at
    http://www.trinity.edu/rjensen/Fraud001.htm#Ernst

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


    "Heads Up Play With David Einhorn," by Bess Levin, DealBreaker, December 21, 2010 --- Click Here
    http://dealbreaker.com/2010/12/heads-up-play-with-david-einhorn-a-qa/?utm_source=feedburner&utm_medium=feed&utm_campaign=Feed%3A+dealbreaker+%28Dealbreaker%29

    If you’re going to commit financial fraud, you probably don’t want to find yourself sitting at a table across from David Einhorn, who will know what you’re up to and share it with the world. Similarly, if you’ve never played poker and have only ever had a 15 minute tutorial on the game, you probably should avoid playing with the Greenlight Capital founder, whose vastly superior skills will demonstrate just how much you suck. As I like to live on the edge, yesterday in an undisclosed location, I choose not to heed the wisdom of the latter. Over several hands, Einhorn and I discussed the new edition of his 2008 book, “Fooling Some Of The People, All Of The Time.”

    The latest version includes an epilogue, and concludes the story of Allied and Einhorn’s years of trying to get other people to listen when he said something was up. As we now know, Allied’s shares collapsed, Greenlight collected $35 million, and the hedge fund made another big (and correct) call on a bank called Lehman Brothers, whose failure was, according to Einhorn, “the Allied story all over again,” just on a bigger scale, with more resounding consequences. Even after the last crisis, which should have been a wake-up call, Einhorn doesn’t think we’ve changed much and if anything, the reforms passed only “encourage poor behavior and will likely foster an even bigger crisis.” He and I chatted about that exciting event, Quantitative Easing, Steve Eisman’s illicit pleasure of choice and more, plus poker tips for people who really, really need them.

    Continued in article

    An older tidbit from http://www.trinity.edu/rjensen/Fraud001.htm

    Selling New Equity to Pay Dividends:  Reminds Me About the South Sea Bubble of 1720 ---
    http://en.wikipedia.org/wiki/South_Sea_bubble

    "Fooling Some People All the Time"

    "Melting into Air:  Before the financial system went bust, it went postmodern," by John Lanchester, The New Yorker, November 10, 2008 --- http://www.newyorker.com/arts/critics/atlarge/2008/11/10/081110crat_atlarge_lanchester

    This is also why the financial masters of the universe tend not to write books. If you have been proved—proved—right, why bother? If you need to tell it, you can’t truly know it. The story of David Einhorn and Allied Capital is an example of a moneyman who believed, with absolute certainty, that he was in the right, who said so, and who then watched the world fail to react to his irrefutable demonstration of his own rightness. This drove him so crazy that he did what was, for a hedge-fund manager, a bizarre thing: he wrote a book about it.

    The story began on May 15, 2002, when Einhorn, who runs a hedge fund called Greenlight Capital, made a speech for a children’s-cancer charity in Hackensack, New Jersey. The charity holds an annual fund-raiser at which investment luminaries give advice on specific shares. Einhorn was one of eleven speakers that day, but his speech had a twist: he recommended shorting—betting against—a firm called Allied Capital. Allied is a “business development company,” which invests in companies in their early stages. Einhorn found things not to like in Allied’s accounting practices—in particular, its way of assessing the value of its investments. The mark-to-market accounting that Einhorn favored is based on the price an asset would fetch if it were sold today, but many of Allied’s investments were in small startups that had, in effect, no market to which they could be marked. In Einhorn’s view, Allied’s way of pricing its holdings amounted to “the you-have-got-to-be-kidding-me method of accounting.” At the same time, Allied was issuing new equity, and, according to Einhorn, the revenue from this could be used to fund the dividend payments that were keeping Allied’s investors happy. To Einhorn, this looked like a potential Ponzi scheme.

    The next day, Allied’s stock dipped more than twenty per cent, and a storm of controversy and counter-accusations began to rage. “Those engaging in the current misinformation campaign against Allied Capital are cynically trying to take advantage of the current post-Enron environment by tarring a great and honest company like Allied Capital with the broad brush of a Big Lie,” Allied’s C.E.O. said. Einhorn would be the first to admit that he wanted Allied’s stock to drop, which might make his motives seem impure to the general reader, but not to him. The function of hedge funds is, by his account, to expose faulty companies and make money in the process. Joseph Schumpeter described capitalism as “creative destruction”: hedge funds are destructive agents, predators targeting the weak and infirm. As Einhorn might see it, people like him are especially necessary because so many others have been asleep at the wheel. His book about his five-year battle with Allied, “Fooling Some of the People All of the Time” (Wiley; $29.95), depicts analysts, financial journalists, and the S.E.C. as being culpably complacent. The S.E.C. spent three years investigating Allied. It found that Allied violated accounting guidelines, but noted that the company had since made improvements. There were no penalties. Einhorn calls the S.E.C. judgment “the lightest of taps on the wrist with the softest of feathers.” He deeply minds this, not least because the complacency of the watchdogs prevents him from being proved right on a reasonable schedule: if they had seen things his way, Allied’s stock price would have promptly collapsed and his short selling would be hugely profitable. As it was, Greenlight shorted Allied at $26.25, only to spend the next years watching the stock drift sideways and upward; eventually, in January of 2007, it hit thirty-three dollars.

    All this has a great deal of resonance now, because, on May 21st of this year, at the same charity event, Einhorn announced that Greenlight had shorted another stock, on the ground of the company’s exposure to financial derivatives based on dangerous subprime loans. The company was Lehman Brothers. There was little delay in Einhorn’s being proved right about that one: the toppling company shook the entire financial system. A global cascade of bank implosions ensued—Wachovia, Washington Mutual, and the Icelandic banking system being merely some of the highlights to date—and a global bailout of the entire system had to be put in train. The short sellers were proved right, and also came to be seen as culprits; so was mark-to-market accounting, since it caused sudden, cataclysmic drops in the book value of companies whose holdings had become illiquid. It is therefore the perfect moment for a short-selling advocate of marking to market to publish his account. One can only speculate whether Einhorn would have written his book if he had known what was going to happen next. (One of the things that have happened is that, on September 30th, Ciena Capital, an Allied portfolio company to whose fraudulent lending Einhorn dedicates many pages, went into bankruptcy; this coincided with a collapse in the value of Allied stock—finally!—to a price of around six dollars a share.) Given the esteem with which Einhorn’s profession is regarded these days, it’s a little as if the assassin of Archduke Franz Ferdinand had taken the outbreak of the First World War as the timely moment to publish a book advocating bomb-throwing—and the book had turned out to be unexpectedly persuasive.

    Heavy Insider Trading --- http://investing.businessweek.com/research/stocks/ownership/ownership.asp?symbol=ALD

    Allied's independent auditor is KPMG
    KPMG has a lot of problems with litigation --- http://www.trinity.edu/rjensen/fraud001.htm

    Bob Jensen's threads on the collapse of the Banking System are at http://www.trinity.edu/rjensen/2008Bailout.htm

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

    Bob Jensen's threads on accounting theory are at http://www.trinity.edu/rjensen/theory01.htm
    Also see the theory of fair value accounting at http://www.trinity.edu/rjensen/theory01.htm#FairValue

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

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


    "How I became a con artist:  I scammed department stores and gyms and book chains. You'd be surprised how easy it was to lie -- and get away," by Jason Jellick, Salon, November 29, 2010 ---
     http://www.salon.com/life/feature/2010/11/29/life_as_an_amateur_con/index.html

    I got my start in my late teens. My mother had a consignment shop/bridal store, which every so often garnered the odd donation of designer clothes. Since this wasn't exactly the kind of place someone came to buy Tommy Hilfiger jeans or a Ralph Lauren sweater, my mother gave me the pick of the donations. Once in a while, I'd find something that fit me, but most of the time, I was hunting for returnables, clothes I could pass off as having been bought somewhere else.

    In those days, J.C. Penney had the loosest return policy. No receipt? No tags? No problem. They gave the item a once-over and found something comparable in quality to gauge the price. Most stores issued a gift card to a customer without any real evidence of purchase; J.C. Penney always gave cash.

    This was in the mid-1990s, before you had to show ID, sign a slip of paper and answer a battery of questions from the always skeptical supervisor. It was just you, the cashier -- and a question of control. You always had to know who was going to be behind that register. That was the golden rule: know your mark. Know whom you could work over and whom you couldn't.

    This was something I learned from watching my mother, who knew all too well how to root out a good con. Her defining scam was the Christmas special, when, on the day after Christmas, she'd gather up the presents from under the tree and return them to the stores along with the masses -- poor Mommy forced to return all of her thoughtful gifts. But unlike most of those people, she'd circle back to the stores (once the shift change had taken effect) and repurchase those same presents for vastly reduced prices. Was this out of necessity? Was it out of some need to display her cunning? Looking back, I suspect my mother had become convinced of some higher moral agenda, in which the weak (the middle class) outfox the strong (the rich). All I know is that we always got what we wanted for Christmas.

    My mom sold the consignment shop when I was in my 20s. By then, I'd decided to become a writer, having fallen in love with "The Catcher in the Rye" at the age of 17. A college student lacking the funds to feed my literary appetite (and with a habit of underlining passages that eliminated the public library as an option), I stopped returning clothes -- and started returning books.

    This scam demanded a little more effort. It required "the pre-con, " as I called it, when I scoured my local Salvation Army and Goodwill for 75 cent paperbacks with sharp, clean edges and un-blemished pages. I'd buy 15 or 20 at a time and then organize them into semi-thematic groups to sell back to one of the chain bookstores. It was best to keep certain types of books together -- self-help with chick lit, biography with history, science fiction with mystery. Trying to return Walter Isaacson's biography of Einstein with, say, a book from the Harry Potter series could elicit enough suspicion to blow the return. Instead, I kept things simple and precise -- three or four books that fit with whatever persona I was trying on that day -- and I'd use the store credit to buy the paperbacks I really wanted. I must have pocketed $150 to $200 in books every month for the better part of a year.

    My biggest single score came when I discovered a dollar store that sold remainders. I bought a hardcover about Richard Nixon with a list price of $35, walked it to the bookstore and left with a gift card for the full amount. Then I went back to the dollar store and bought all eight remaining copies, returning them sporadically over the next year.

    I did have two basic rules: I only conned corporations, never individuals -- and I did not shoplift. Shoplifting wasn't any worse morally; I just thought it was too easy. Instead, I was after a challenge. Sure, it was nice to get a few bucks or a gift card, but the real thrill came from my ability to manipulate, to outwit a large corporation. I wasn't just stealing; I was striking a blow for the common man against Big Business.

    It was around this time that I began telling my friends about my exploits. But instead of being disdainful or horrified, I saw a look of amazement and envy in their eyes, and it fed my desire to try new cons. I discovered the McDonald's drive-thru could be exploited if you happened to be out with your hungry 6-year old nephew sans wallet and sounded particularly desperate. I discovered that if you called the front desk of a certain five-star hotel and told them that every time you turn on the TV you were assaulted by images of pornography -- and your wife is pregnant and she doesn't want to see this crap, for Chrissakes -- they'll gladly upgrade you to a suite at no extra charge. But what I really learned is that people will believe just about anything you tell them, if you channel the right persona.

    I discovered just how susceptible people were to the right persona when, for over a year, I attended my local gym in California without becoming a member. I never knew what I was going to say to the worker at the front desk. This is because when you're conning someone, you must always give the illusion that your mind is on something else. Affable indifference works well. For the gym, I used athletic focus. Never once did I approach the front desk walking. I was always running, always in the zone, always pumped. I'd have my earphones in, music blaring, and say that I'd just taken a run around the block (interval training); I'd have my basketball shoes in hand and feign anxiety as I approached: Did the game start already? I'd shake my head impatiently and say that I had to feed the parking meter, briefly criticizing the city's parking regulations, and every time, the worker would sympathize, hand me a towel and tell me to have a good workout.

    Yes, it was all about persona, and every encounter enabled me to tweak my persona -- a regimen of creation and re-creation, a perpetual self-sharpening: Hi, I bought this book the other day and I got it home and found that there was writing inside! (Of course, beforehand, I'd go hide the remaining copies of said book so the cashier would be forced to give me a store credit); hi, I bought this shirt the other day and the cashier said that it wouldn't shrink if I washed it, but it shrunk; hi, you know, I'm not really sure, I'm just making this return for my wife … my mother … my sister … my sick grandmother; hi, I got this as a graduation gift … a christening gift … a shower gift ... a birthday gift; hi, I forgot my key card upstairs in my room, is it possible to get another one to get into the fitness center?; hi, no, I'm sorry, but I don't have my receipt; hi, well I would like to speak to the manager, please.

    And each one of these gambits required a follow-up if the situation didn't go as planned:

    So this is the kind of product you sell in your store? I don't think I want to exchange it because it'll just shrink again; ummm? I think it'll probably be better if I just get them a store credit, that way they can pick out what they want; my name? Jack O'Brien. But the room may be under my mother's name -- oh, for some reason she kept her maiden name, I don't know why ... yeah, Burblonsky, that's her; look, I'm not trying to pull one over on you (said with a laugh to underscore the absurdity of the idea), I would like to just return this item and pick out something else; I work hard for my money; THIS IS RIDICULOUS!

    Things changed after Minnesota. My wife, Kate, and I were driving back east from California and were on our way to see my friend Lisa in Minneapolis. We rarely saw each other, and I wanted to look nice for the visit. Kate had never met Lisa, so she wanted to look nice, too.

    We didn't look nice. We didn't smell nice. We needed a shower and, of course, I had a con in mind.

    In the first hotel, we hit a snag. We asked to see a room and had fully expected the woman at the desk to give us a key, but she didn't. She walked us to the room and stood by as we inspected. Kate looked scared.

    After making a show of looking around, I asked if breakfast was included. Kate looked at me like I was crazy. It was 1 p.m., and we were due in Minneapolis in two hours.

    "OK, it's perfect," I said.

    The woman led us to the door, and before we left the room I said: "Could my wife stay here? She's pregnant, and her feet are killing her."

    The woman was sympathetic and as she and I boarded the elevator, I figured Kate would already be in the shower.

    When we got to the front desk, I said I'd left my wallet in the car. When I came back inside, I said that my wife had it in her purse, upstairs. This all took about 10 minutes -- more than enough time for a person to shower, but when I reached the room, I found Kate sitting on the corner of the bed, terrified.

    "I can't do this," she said.

    Continued in article


    Jensen Question
    Does anybody see something in this deal that does not screw taxpayers for the benefit of big bankers?
    Or is this just a sweetheart deal for the FDIC and its billionaire friends?
    Or am I missing something here?

    Dr. Wolff sent me a link to this video.
    Video --- http://www.youtube.com/user/fiercefreeleancer

    I really was not aware of how this thing really worked, so I found a link to the following document:

    "FDIC's Sale of IndyMac to One West Bank - Sweetheart deal or not?" by Dennis Norman, Real Estate Investors Daily, February 15, 2010 ---
    http://realestateinvestordaily.com/market-information-news/fdics-sale-of-indymac-to-one-west-bank-sweetheart-deal-or-not/

    Last week a friend emailed me a link to a video titledThe Indymac Slap in Our Facethat was created by Think Big Work Small. I watched the video which gave a recap of the failure of Indymac bank back resulting in it’s seizure by the FDIC in July, 2008, and the ultimate sale by the FDIC of Indymac Bank to One West Bank in March, 2009.

    According to the video, One West Bank received a cushy, “sweetheart deal” and implied it was related to the fact that the owners of One West Bank include Goldman Sachs VP, Steven Mnuchin, billionaires George Soros and John Paulsen, and that “it’s good to have friends in high places.” Here is a recap of some of the “facts” of the deal they gave on the video:

    • One West Bank paid the FDIC 70 percent of the principal balance of all current residential loans
    • One West Bank paid the FDIC 58 percent of the principal balance of all HELOC’s (Home Equity Lines of Credit)
    • The FDIC agreed to cover 80 – 95 percent of One West’s loss on an Indymac loan as a result of a short sale or foreclosure.
      • The kicker is, according to the video, is that the “loss” is computed based upon the original loan amount and not the amount One West paid for the loan.

    On the video the hosts give an example of an “actual scenario” showing how the deal worked, below is a recap:

    • One West Bank approved a short-sale of $241,000 on one of the Indymac loans it purchased from the FDIC (the total balance owed by the borrower at the time was $485,200).
    • Based upon the terms of the loss sharing agreement, One West “lost” $244,200 on this transaction, 80 percent of which ($195,360) was paid to One West by the FDIC.
    • So, One West received $241,000 from the short sale and $195,360 from the FDIC for a total of $436,360 on a loan they bought from the FDIC for $334,600, thereby resulting in a profit of $101,760 on the loan to One West.
    • One last kicker, the video claims, in addition to making over $100,000 on the loan, since the house was sold for less than what the borrower owed, One West also made the borrower sign a promissory note for $75,000 of the short-fall.

    Below is a link to the video if you want to watch it for yourself.

    ThinkBigWorkSmall.com Video --- http://www.thinkbigworksmall.com/mypage/archive///

    The video got me pretty fired up like I imagine it did most people that saw it. Afterall, our federal government is running up debt faster than ever before, the FDIC has had to take over a record number of banks in the past year and now a sweetheart deal for people that are “connected.” OK, I’ll admit it, I was a little jealous….a 30 percent profit, guaranted by the FDIC? And all I have to do is discourage borrowers from doing loan modifications and force short-sales and foreclosures? Easier than taking candy from a baby, huh?

    Hmm….wait a minute though, the skeptic in me (especially when it comes to anything distributed via email) made me wonder if the video was accurate or was it misunderstanding the facts, taking facts out of context or simply just wrong? To the credit of Think Big Work Small they did have links on their site to the loss-sharing agreement they were referencing.

    I went to the FDIC website and found what I believe to be the original Indymac sale agreement as well as the loss sharing agreement with One West Bank as well as a supplemental information document on the sale the FDIC published after the sale.

    Following are some highlights from the FDIC “Fact Sheet” on the sale of IndyMac:

    • The FDIC entered into a letter of internt to sell New IndyMac to IMB HoldCo, LLC, a thrift holding company controlled by IMB Management Holdings, LOP for approximately $13.9 billion. IMB holdCo is owned by a consortium of private equity investors led by Steven T. Mnuchin of Dune Capital Management LP.
    • The FDIC has agreed to share losses on a portfolio of qualifying loans with New IndyMac assuming the first 20 percent of losses, after which the FDIC will share losses 80/20 for the next 10 percent and 95/5 thereafter.
    • Under a participation structure on approximately $2 billion portfolio of construction and other loans, the FDIC will receive a majority of all cash flows generated.
    • When the transaction is closed, IMB HoldCo will put $1.3 billion in cash in New IndyMac to capitalize it.
    • In an overview of the Consortium it does identify “Paulson & Co” as a member as well as “SSP Offshore LLC”, which is managed by Soros Fund Management.

    Just about the time I finished researching everything for this article I received a press release from the FDIC in response to the video which stated “It is unfortunate but necessary to respond to the blatantly false claims in a web video that is being circulated about the loss-sharing agreement between the FDIC and One West Bank.” The press release goes on to give these “facts” about the deal:

    • One West has “not been paid one penny by the FDIC” in loss-share claims.
    • The loss-shre agreement is limited to 7 percent of the total assets that One West services.
    • One West must first take more than $2.5 billion in losses before it can make a loss-share claim on owned assets.
    • In order to be paid through loss share, One West must have adhered to the Home Affordable Modification Plan (HAMP).

    The last paragraph starts with “this video has no credibility.”

    My Analysis

    Before I get into this, I need to point out that while I have reviewed the sale agreement between the FDIC and One West as well as the loss-sharing agreement, watched the video above and read the FDIC’s press release, this is complicated stuff and not easy to understand. However, I think I have my arms around the deal somewhat so the following is my best guess analysis of the IndyMac deal with regard to the loss-sharing provision:

    • The FDIC says the loss sharing agreement only applies to 7 percent of the IndyMac Loans serviced by One West. It appears there is $157.7 billion in loans serviced, 7 percent of that amount is about $11 billion. So my guess is the loss-share applies to about $11 billion worth of loans.
    • One West agreed to a “First Loss Amount” of 20 percent of the shared-loss loans. The attachment for this was blank but the FDIC’s press release indicates this amount is $2.5 Billion. If that is the case then the total amount of loans the loss-share provision applies to is $12.5 billion. Obviously there is a $1.5 billion discrepancy between my calculation above and here (what’s $1.5 billion among friends?) but I’m going to go with the $12.5 billion because the amount of loans serviced I referenced may have been adusted at closing.
    • One West purchased the $12.5 billion in loans covered by the loss-sharing agreement for less than $8.75 billion. I say “less than” $8.75 billion as that is 70 percent of the loan amount which represents the amount One-West paid for residential loans that were current. The amount paid for current HELOC’s was only 58 percent and the price for delinquent mortgages went as low as 55 percent and as low as 37.75 percent for delinquent HELOC’s. Therefore I would assume the actual price paid by One-West was less than the $8.75 billion.
    • Once One West has covered $2.5 billion in losses, then the FDIC starts covering 80 percent of the losses up to a threshold at which time the FDIC covers 95 percent of the losses. Figuring out the threshold was a little trickier…I see a reference to 30 percent of the total loans covered by the loss-share so I’m going to use that which works out to $3.75 billion.

    Now let’s figure the profit One West stands to make on the loans covered by the Loss-Share agreement;

    • If all the borrowers would pay off their loans in full, not less than $3.75 billion (not likely though that all borrowers will pay off in full).
    • Let’s be real pessimistic and look at the “worst-case” scenario: Lets say 100 percent of the loans bought by One West (covered by the loss-share) go bad and have to be short-sales or foreclosures at a loss. For the sake of conversation lets say the losses equal 40 percent of the loan amount, or $5 billion ($12.5 billion times 40 percent).
      • One West would have to cover the first $2.5 billion at which time the 80/20 rule would kick in for the next $1.25 billion in losses resulting in One West recovering $1.0 billion of those losses from the FDIC. Then for the next $1.25 billion ($3.75 to $5 billion) One West would recover 95 percent of the loss fro the FDIC or $1.1875 billion.
        • Recap: Of the $12.5 billion in loans, under the scenario above, One West would have realized $7.5 billion from foreclosures or short sales (60 percent of the debt) and would have recovered $2.1875 billion from the FDIC of the $5 billion in losses, for a total to One West of $9.6875 billion for loans they paid not more than $8.75 billion for a profit of a little less than $1 billion.

    Keep in mind, my analysis above is based somewhat on fact and some on speculation and my “profit” scenario is based purely on speculation and pretty negative assumptions as to loan losses. This coupled with the fact that, as I stated above, One West probably bought the loans for less than I indicated, probably makes this a better deal with more than the $1 billion profit at the end of the day.

    So is is a sweetheart deal or not? You be the judge…

    One thing to keep in mind is the investors only put $1.3 billion cash into the deal to buy IndyMac, and they got a lot more than just the loans covered by the loss-sharing agreement. I’m thinking it’s a pretty good deal and one I probably would have jumped on…well, if I had $1.3 billion sitting around doing nothing…

    Jensen Question
    Does anybody see something in this deal that does not screw taxpayers for the benefit of big bankers?
    Or is this just a sweetheart deal for the FDIC and its billionaire friends?
    Or am I missing something here?

    Bob Jensen

    Unrelated reference
    "Fed to Banks: Quit Stalling on Short Sales" --- http://www.housingwatch.com/2010/01/13/fed-to-banks-quit-stalling-on-short-sales/


    A New Teaching Module for Ethics Courses:  Channel Checking and Trading

    Question
    When should channel checking (e.g., traders bribing employees of trade channel suppliers and distributors) and channel trading (e.g., trading by Minnie Pearl in a supplier's Accounts Receivable Department in securities or derivative securities of customers)?

    "Who’s Checking Your Channel?" by Bruce Carton, Securities Docket, December 8, 2010

    Two months ago I declared September 2010 “Insider Trading Month” for the Securities and Exchange Commission’s sudden burst of enforcement activity on that front. Then came November, and boy, did enforcement go off the charts.

    The extraordinary activity of prosecutors and regulators that month set Wall Street traders abuzz, but compliance officers and other executives at public companies should also take careful notice. And what’s so different about the latest round of insider-trading cases? Investigators are focusing on the flow of supply-chain information. That includes a lot more people than the gossipy traders working in lower Manhattan.

    On November 20, reports circulated that both the Justice Department and the SEC were preparing insider-trading cases against a long list of Wall Street entities: consultants, investment bankers, hedge fund and mutual fund traders, and analysts. According to the Wall Street Journal, the charges would allege “a culture of pervasive insider trading in U.S. financial markets, including new ways non-public information is passed to traders through experts tied to specific industries or companies.” Two days later, the FBI raided the offices of three hedge funds as part of the investigation, with more raids expected.

    Portions of the investigation are fairly standard—hedge funds tipped off to pending merger deals, for example; that’s nothing new under the sun. But another wrinkle has equity research analysts on red alert. Regulators are now thought to be probing whether an analyst practice commonly known as “channel checking” constitutes illegal insider trading. If so, the public companies whose information is in play could soon be pulled into the whirlwind.

    One company where channel checks have reportedly now become a widely used and highly relied-upon source of information for traders is Apple.

    In a channel check, analysts try to glean information about a company’s production via interviews with the company’s suppliers, distributors, contract manufacturers, and sometimes even current company employees. The goal is to piece together a better picture of the company’s performance. Apple, always secretive about its products, is an example of a company where channel checking is reportedly common. Indeed, analyst reports based on channel checks routinely cause Apple stock to dip or surge.

    As supply-chain expert Pradheep Sampath of GXS noted on his blog, these interviews typically occur without the target company’s permission or participation. Sampath adds that:

    Data collected from these sources is seemingly innocuous when viewed separately. When pieced together however, these data points from a company’s supply chain can deliver startling insights into revenue and future earnings of a company—much in advance of such information becoming publicly available. This practice becomes more pronounced for companies such as Apple that are extremely guarded and secretive about information they make publicly available.

    Reasons abound to question whether the Justice Department or the SEC will ever decide to bring a channel-checking case. First, the information gleaned from any one individual in the channel is unlikely to be material by itself. For example, the maker of screens for Apple’s iPhones may reveal that sales of those screens to Apple ticked up in December. But given that Apple has so many revenue streams and just as many channels for those streams, this one detail from our screen-maker is not likely to be material by itself.

    Only when that information is pieced together with many other pieces of information to build a “mosaic” does a larger picture emerge that might arguably be material information about the company. This is, in effect, what equity research analysts are paid to do. But as the U.S. Supreme Court stated in the SEC’s ultimately unsuccessful insider-trading case against research analyst Raymond Dirks, analysts play an important role in preserving a healthy market, and imposing “an inhibiting influence” on that role may not be desirable.

    Nonetheless, if prosecutors are now scrutinizing analysts’ practices of gathering information from a public company’s supply chain—which have a long, established history—that presents an important opportunity for public companies to re-examine their own policies and procedures concerning how such information is tracked and controlled. Here are some questions that public companies will want to consider:

    1. Are analysts interested in, and attempting to obtain, information from our supply-chain?

    If not, then channel checks may be more of a back-burner issue for you. If yes, press on.

    2. As part of our agreements with suppliers, distributors, and manufacturers, do we have confidentiality or non-disclosure agreements (NDAs) in place?

    Implicit in any enforcement action or prosecution that might result from the ongoing channel-check probe is the idea that the information in question is confidential and a company’s suppliers should not be sharing it. Suppliers speaking to Apple analysts, for example, may well be violating NDA agreements with Apple and allowing analysts to access confidential information. That doesn’t differ much from committing insider trading by obtaining information from inside the company itself.

    If the SEC and prosecutors now view supply-chain information as material, non-public information that can support an insider-trading case, then companies should take a fresh look at how they try to prevent the misuse of such information.

    Jacob Frenkel, a former SEC enforcement attorney now with law firm Shulman, Rogers, Gandal, Pordy & Ecker, says that weak corporate controls over supply chains has been a looming issue and was bound to become a compliance headache sooner or later. Frenkel says companies should adopt rules governing the conduct of their business partners, including what information they may share.

    3. If we do have confidentiality agreements or NDAs in place with suppliers, distributors, and manufacturers, are they being violated? And are we seeking to enforce them?

    To continue the Apple example: If traders routinely receive and act upon analyst reports based on supply chain interviews about the company, one wonders whether any NDAs with suppliers are in place or enforced. (Regulators would certainly be wondering about it.) For the record, Apple told the Wall Street Journal that the company does not release that type of information about its production, and declined to comment further.

    Consider this hypothetical:

    Company X’s supply-chain information is material and non-public, meaning Company X or a “person acting on its behalf” could not selectively disclose it to one analyst under Regulation FD without making a public disclosure of that same information; Company X is fully aware that its suppliers are providing supply-chain information regularly to select analysts; and Company X either (a) does not impose an NDA on its suppliers, or (b) does impose an NDA but never enforces it. Is the supplier’s disclosure of information to select analysts, with Company X’s knowledge, a “back door” violation of Regulation FD (or at least the spirit of Regulation FD)?

    4. Are we permitting current company employees to hold discussions with analysts or traders as industry “consultants”?

    Law professor Peter Henning noted in a recent article that many employees are providing information as consultants do so openly, and “it may even be that these consultants were authorized by corporate employers—or it was at least tolerated as a cost of keeping talented employees.” Given the risk that an employee/consultant may end up talking about the company, however, Henning says it is an “interesting issue” why a company would allow one of its employees to consult in this fashion.

    Given the SEC’s intense focus on insider trading, there is certainly more to come on this front, so keep an eye on developments in the coming months. And keep an ear to the ground for those whispers from your suppliers, distributors, and contract manufacturers.

    Jensen Comment
    If it is not illegal to pay Joe on the loading dock for information, this can get terribly complicated. Joe might seek work on the loading dock for the sole purpose of eliciting bribes from traders and hedge fund managers. Suppose Joe gets paid by Trader A to slip information on the types of components being shipped to an iPad assembly plant such as information that iPad is shipping in millions of USB ports. Further suppose Trader B then pays Joe to slip Trader A false information such as falsely claiming iPad is shipping in millions of USB ports.

    As another scenario suppose that Minnie Pearl in the Accounting Department of a USB port manufacturer works in the Accounts Receivable Department. She sees a lot of her employer's billings go out to the iPad plant --- I think you get the picture of how Minnie Pearl donned a new straw hat, moved to Nashville, and bought an expensive acreage that once belonged to another woman named Minnie Pearl.

    The fraud hazards in channel probing are indeed complicated and very difficult to regulate.

    Bob Jensen threads on dirty rotten frauds are at
    http://www.trinity.edu/rjensen/FraudRotten.htm


    "Extent of Corporate Tax Evasion when Taxable Earnings and Accounting Earnings Coincide," by Paul Caron, Tax Prof Blog, December 12, 2010 ---
    http://taxprof.typepad.com/

    Stavroula Kourdoumpalou & Theofanis Karagiorgos (both of University of Macedonia, Department of Business Administration) have posted Extent of Corporate Tax Evasion when Taxable Earnings and Accounting Earnings Coincide on SSRN. Here is the abstract:

    This study attempts to contribute to the literature of fraudulent financial reporting by focusing on one specific form of fraud, corporate tax evasion. Relevant research is rather limited, since tax audit data are not publicly available because of privacy reasons. However, the legal framework in Greece offers a unique opportunity to study the extent of corporate tax evasion as it obligates the public companies to publish the outcomes of the tax audits. On the basis of this data, we estimated the mean rate of tax evasion at about 16% for the years both before and after the companies went public. This shows, first of all, that the incentive for tax evasion doesn’t diminish when the companies are listed in the stock exchange. Specifically, it was found out that the companies alter their tax behaviour (i.e. appear more tax compliant) only in the year of the IPO and in the year before. Moreover, the findings of the study show that the level of tax evasion constitutes accounting fraud and, as tax and financial accounting aligned for the years under study, leads to materially misleading financial statements. In this framework, we also find significant evident that the type of the audit firm can affect the extent of tax evasion committed.

    Also see "Offshore Tax Evasion, With a Focus on Switzerland" ---
    http://taxprof.typepad.com/taxprof_blog/2010/12/offshore-tax-evasion-with-a-focus-on-switzerland.html#more

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

     


    "Green Mountain Coffee Roasters: Gosh, We Ended Up Having Way More Accounting Errors Than We Thought," by Caleb Newquist, Going Concern, November 22, 2010 ---
    http://goingconcern.com/2010/11/green-mountain-coffee-roasters-gosh-we-ended-up-having-way-more-accounting-errors-than-we-thought/#more-21771

    Back in September, Vermont-based Green Mountain Coffee Roasters put the world on notice that the SEC was asking some questions about their revenue recognitions policies. Despite the SEC Q&A, analysts we’re cool with the company and the GAAP the crunchy accounting group was putting out.

    Also at that time, the company disclosed that there were some immaterial accounting errors that were NDB. That was until they dropped a little 8-K on everyone last Friday!


    Turns out, there was a
    whole mess of accounting booboos and the company will be restating “previously issued financial statements, including the quarterly data for fiscal years 2009 and 2010 and its selected financial data for the relevant periods.”

    Continued in article

    From the now infamous 8-K ---
    http://sec.gov/Archives/edgar/data/909954/000119312510265256/d8k.htm

    The audit committee and management have discussed the matters disclosed in this current report on Form 8-K with PricewaterhouseCoopers LLP, the Company’s independent registered public accounting firm. The Company is working diligently to complete the restatement of its financial statements. The Company expects to file its annual report on Form 10-K, including the restated financial statements, by no later than December 9, 2010, the expiration date of the extension period provided by Rule 12b-25 of the Securities Exchange Act of 1934, as amended. However, there can be no assurance that the filing will be made within this period.

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

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


    October 27, 2010 message from Bob Jensen

    Hi David,

    I once had a professor who asserted in class that America was a land of cop haters who despised the scum that ratted to the cops for whatever reason --- a posted reward, a lighter sentence, media attention, book royalties, guilty conscience, religious guilt/fear, personal revenge, or whatever.

    American is also a land where it's often very difficult to detect perpetrators of crimes and to get convictions without despised scums that rat/snitch to the cops. The most important power of the police is that of being the place where whistleblowers/informants come forth to aid in detecting perpetrators of crimes and to help in gaining convictions in court.

    I would not say I'm such a huge fan of whistleblowers. I just don't despise them as much as dastardly criminals. And I'm a realist who genuinely feels that many more criminals would go scott free if it were not for whistleblowers/informants.

    I also think that we sometimes dwell on motives we don't respect (e.g., collecting rewards, book royalties, and revenge) and overlook the price paid by whistleblowers (ostracism, loss of friends, loss of job, loss of career, loss of savings, loss of respect, and fear of retaliation).

    Thus we are torn between hating whistleblowers and desperately needing them for the criminal justice system. I would assert that nearly all corporate frauds have been uncovered because of whistleblowers and not internal or external auditors acting without the help of some whistleblowers along the way. Of course, sometimes the whistleblowers are also auditors who sometimes see the need to bypass the chain of command.

    Trivia Questions
    Who were the famous whistleblowers working for Enron and WorldCom?
    How did they bypass the chain of command? (especially interesting in the case of Enron)

    Hint:  Both were women accountants!

    Bob Jensen's threads on Enron and WorldCom ---
    http://www.trinity.edu/rjensen/FraudEnron.htm

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


    "Ernst & Young aide gets 30 months for embezzling." by  Henry K. Lee, San Francisco Chronicle, October 27, 2010 ---
     http://www.sfgate.com/cgi-bin/article.cgi?f=/c/a/2010/10/27/BUIL1G2QJB.DTL#ixzz13gjFM8R8

    An executive assistant at the giant accounting firm Ernst & Young has been sentenced to more than two years in federal prison for a $1.7 million embezzlement scheme that helped finance a posh San Francisco home, two BMWs, jewelry and stays at luxury resorts, authorities said Wednesday.

    Lily Aspillera, 65, of San Francisco was ordered Tuesday by U.S. District Judge Susan Illston to serve 30 months behind bars for mail fraud and tax evasion.

    "Like so many who commit fraud, over time she increased the amount of money she embezzled, apparently emboldened by not getting caught," Assistant U.S. Attorney Doug Sprague wrote in a sentencing memorandum.

    Defense attorney Donald Bergerson wrote in court papers that his client "has been punished by her own conscience as much as she can be punished by any term of imprisonment."

    From 2002 to 2008, Aspillera wrote more than $1 million in checks that were drawn from the accounts of one of Ernst & Young's clients and made them payable to herself and to "cash."

    She also wrote checks drawn on the client's accounts payable to two of the client's employees for amounts greater than they were due and then had those employees cash the checks and give the excess cash back to her, federal prosecutors said.

    Aspillera used the ill-gotten gains for stays at luxury resorts, golf trips and the purchase of two BMWs and jewelry worth more than $200,000. She also used $180,000 for a down payment on a $1.1 million home in San Francisco's St. Francis Wood neighborhood

    Aspillera must repay the $1.7 million as well as back taxes of $644,843.

    Read more: http://www.sfgate.com/cgi-bin/article.cgi?f=/c/a/2010/10/27/BUIL1G2QJB.DTL#ixzz13gjpvGLX

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

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


    From The Wall Street Journal Accounting Weekly Review on October 29, 2010

    Shareholders Hit the Roof Over Relocation Subsidies
    by: Joann S. Lublin
    Oct 25, 2010
    Click here to view the full article on WSJ.com

    TOPICS: Board of Directors, Corporate Governance, Executive Compensation, Financial Reporting


    SUMMARY: "Activist investors are turning up the heat on companies that give relocating executives generous benefits to cover the cost of their depressed home values....The root problem: The protracted housing downturn in the U.S. is colliding with a rebound in management hiring. So more employers help pick up the tab for relocated executives losing money on their home sales." The issue could become more visible next year with the implementation of the "say on pay" component of the financial-overhaul legislation requiring shareholder advisory votes on executive compensation.
    CLASSROOM APPLICATION: The article is useful in any class covering corporate governance and/or executive compensation.


    QUESTIONS:
    1. (Introductory) What benefits are being paid to top executives at many U.S. corporations when they hire?

    2. (Advanced) What investor groups are opposing these practices? Explain who these investors groups are and how they help to all investors to focus on governance issues such as this one. In your answer, also define the notion of "corporate governance."

    3. (Introductory) What is "say on pay"? When was a U.S. government provision on "say on pay" implemented?

    4. (Advanced) Why will "say on pay" requirements likely cause more of a stir in corporate annual meetings with shareholders next year?

    Reviewed By: Judy Beckman, University of Rhode Island


    "Shareholders Hit the Roof Over Relocation Subsidies," by: Joann S. Lublin, The Wall Street Journal, October25, 2010 ---
    http://online.wsj.com/article/SB10001424052702303864404575571972286910174.html?mod=djem_jiewr_AC_domainid

    Activist investors are turning up the heat on companies that give relocating executives generous benefits to cover the cost of their depressed home values.

    Microsoft Corp. and Wal-Mart Stores Inc. may face investor criticism at their next annual meetings. So far this year, proxy adviser Institutional Shareholder Services has urged investors to oppose the re-election of directors who oversaw home-loss payouts at eight concerns, including Electronic Arts Inc. and Boston Scientific Corp. That's twice the number in 2009.

    Home-loss subsidies could become more contentious next year, when all U.S. public companies must hold an advisory investor vote on executive pay—as mandated by the new financial-overhaul law. ISS expects such payments will influence whether it endorses executive-pay practices.

    The root problem: The protracted housing downturn in the U.S. is colliding with a rebound in management hiring. So more employers help pick up the tab for relocated executives losing money on their home sales.

    Experience WSJ professional Editors' Deep Dive: Shareholder Activism a Growing TrendMERGERS & ACQUISITIONS REPORT Proxy Access Rules Create Uncertainty .New York Law Journal Dodd-Frank: Selected Provisions on Executive Pay .The Legal Intelligencer Say on Pay Is Here to Stay. Access thousands of business sources not available on the free web. Learn More ."Home-loss provisions are a hot-button issue with our institutional clients," explains Patrick McGurn, special counsel for ISS. "We have been seeing extraordinary relocation payments being made to bail out transferred executives."

    Microsoft may see fireworks over the issue at its annual meeting next month. Stephen Elop, recruited as president of its business division in 2008, got $5.5 million in relocation benefits and related tax payments. The package includes Microsoft's $3.7 million loss on the 2009 sale of his seven-bathroom house in Los Altos Hills, Calif.

    Mr. Elop quit to run Nokia Corp. in September. He had to repay $667,000 of his $2 million signing bonus because he stayed less than three years, but Microsoft had only negotiated a one-year "clawback" for his relocation package.

    View Full Image

    Reuters

    Wal-Mart's Brian C. Cornell .The unrecovered benefits aroused the ire of CtW Investment Group, an arm of labor federation Change to Win, whose union pension funds own Microsoft shares. Hefty home-sale subsidies reflect "the board's failure to appropriately constrain the risk of such egregious non-performance related payments," CtW said in an Oct. 15 letter to Dina Dublon, chairman of Microsoft's board pay panel. The letter urged directors to end home-loss relocation benefits and asked her to discuss similar corrective measures during the annual meeting.

    Microsoft "has taken steps to minimize that kind of risk in the relocation program going forward," a spokesman says.

    In a Friday regulatory filing, the company announced identical recovery periods for relocation payments and signing bonuses plus "reasonable caps" on relocation benefits. Those moves come after the company had already responded to investor criticism by extending relocation-aid clawbacks to two years shortly before its 2009 annual meeting.

    William Patterson, CtW's executive director, praises the changes but says "there's still room for improvement."

    About 74% of companies reimburse some or all of a staff member's home-sale loss, according to a March survey by Weichert Relocation Resources Inc. of 185 companies. That's up from 63% in a similar 2008 survey.

    Nineteen companies divulged largely sizable outlays for residential losses of a relocated senior officer in their latest proxy statement, reports Equilar, an executive-compensation research firm. Seven occurred at the 100 biggest businesses, ranging from Delta Air Lines Inc. to Wal-Mart. No Fortune 100 concern disclosed the reimbursements in their 2007 proxies.

    Proponents defend the perk as necessary for businesses to attract and keep star players. "They simply need those executives to move," says James D.C. Barrall, head of the global executive compensation and benefits practice at Latham & Watkins LLP.

    Continued in article

    Bob Jensen's threads on outrageous executive compensation are at
    http://www.trinity.edu/rjensen/FraudConclusion.htm#OutrageousCompensation


    "A Novel Way to Sidestep Investor Suits," by Floyd Norris, The New York Times, December 2, 2010 ---
    http://www.nytimes.com/2010/12/03/business/03norris.html?_r=3&pagewanted=1

    One of the great legal fictions of Wall Street is that mutual funds are independent of the companies that create and run them.

    It is true such funds have their own boards, nominally elected by fund shareholders, but in practice the funds are run and marketed by the management company. That is a fact that most investors take for granted.

    But it is not a fact the courts should pay much attention to, at least in the opinion of Janus Capital Group, which runs the Janus family of funds. On Tuesday the Supreme Court will hear an appeal by Janus, which seeks to avoid responsibility for a fraud committed at several of its funds.

    The case stems from a scandal that got a lot of attention seven years ago, one involving “market timing” of funds. Janus told investors it did take steps to prevent such trading, in which big traders buy or sell fund shares based on outdated values, and thereby profit at the expense of other investors in the fund. But Janus secretly cut deals with some hedge funds to allow such trading in order to increase the assets on which it could collect management fees.

    The basic facts are not in dispute. Janus settled with the Securities and Exchange Commission in 2004 and paid $100 million in penalties. At the time, an S.E.C. enforcement official said it was clear to the commission that Janus “violated an investment adviser’s fiduciary duty to investors.”

    In its settlement with the S.E.C., Janus agreed that its Janus Capital Management subsidiary, known as J.C.M., would “cause the Janus funds to operate” in accordance with governance policies that would prevent such violations in the future.

    It did not claim that J.C.M. had no control over the funds. But in its brief with the Supreme Court, Janus says that “J.C.M. is neither a primary actor nor a primary violator with respect to the statements” in the prospectuses. “The statements in the Janus Funds’ prospectuses were made by the trust comprising the Janus Funds — a separate legal entity, with its own board of trustees and legal counsel — not by J.C.M.”

    After Janus’s actions were disclosed in September 2003 by Eliot Spitzer, then the attorney general of New York, its stock price plunged, and investors who owned the stock sued. Seven years later, an index of money-management company stocks that includes Janus is up about 15 percent from just before the disclosure. Janus, the worst performer in the group, is down about 40 percent.

    The suit has moved slowly. A district court judge dismissed the case, agreeing with Janus that the company was not responsible for what was in the prospectuses. The suit was reinstated by the United States Court of Appeals for the Fourth Circuit. If the Supreme Court upholds that decision, the class-action suit can proceed to trial. It is more likely that it would be settled.

    The decision by the Supreme Court to even hear the appeal took some by surprise. The court asked the Justice Department to comment, and the department advised against hearing the case. After the court agreed to hear the case, the S.E.C. and the Justice Department urged the justices to rule against Janus.

    That the case could get this far may be an indication of the hostility the courts have shown to securities class-action suits in recent years. In 1994, the Supreme Court ruled that private suits — as opposed to suits brought by the S.E.C. — could not be filed against those who merely aided and abetted someone else’s fraud. In a major case decided in 2008, the court said that two companies that had helped a cable company rig its books could not be sued by investors damaged by the fraud.

    The issues presented by the Janus case make clear that it is not always easy to distinguish whether someone is a primary player in a fraud, or simply helped. That distinction is, however, critical under the Supreme Court precedents.

    Janus argued in its Supreme Court brief that it was “not a primary actor because it did not issue the securities” offered by the inaccurate prospectuses. Instead, it only “provided investment advisory services” pursuant to a contract. Janus places great reliance on the fact the prospectus speaks of Janus as a contractor, not the principal.

    Groups representing accountants and brokerage firms, as well as an insurance company that provides insurance for lawyers, want the court to use the case to make clear that such people as lawyers, underwriters and accountants cannot be viewed as primary actors, and thus are immune from private suits even if they were actively involved in a fraud.

    Continued in article

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


    As with hospitals, over 98% of the billing mistakes screw the customers indicating that the errors are not random
    "FCC Fines Verizon a Record-Breaking $25 Million for Screwing Customers," Gizmoto, October 30, 2010 ---
    http://gizmodo.com/5677758/fcc-fines-verizon-a-record+breaking-25-million-for-screwing-customers

    Remember when Verizon recently said "sorry" to 15 million of its cellphone customers for overcharging them to the tune of $52.8 million? So does the FCC, which just levied a massive $25 million fine against them for the error.

    According to the FCC, the fine is the largest in the agency's history.

    Note: The previously reported $90 million amount Verizon purportedly overcharged data using customers has since been readjusted to the $52.8 million number seen above.

    Jensen Comment
    This reminds me of when the large auditing firms were overcharging clients for travel costs ---
    http://www.trinity.edu/rjensen/Fraud001.htm#BigFirms

    "Audit Firms Overbilled Clients For Travel, Arkansas Suit Alleges," by Jonathan Weil and Cassell Bryan-Low, The Wall Street Journal, September 17, 2003 --- http://online.wsj.com/article/0,,SB106376088299612400,00.html?mod=todays%255Fus%255Fpageone%255Fhs 

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

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

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

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

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

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

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

    Continued in the article

    "Large Size of Travel Rebates Adds to Questions on Ernst," by Jonathan Weil, The Wall Street Journal, November 20, 2003 --- http://online.wsj.com/article/0,,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."

    "Pricewaterhouse's Records Indicate Some Partners Opposed Keeping Payments," by Johathan Weil, The Wall Street Journal, September 19, 2003 --- http://online.wsj.com/article/0,,SB106391830284530300,00.html?mod=mkts_main_news_hs_h

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

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

    Continued in the article.

    "PricewaterhouseCoopers Partners Criticized the Firm's Travel Billing," by Jonathan Weil, The Wall Street Journal, September 30, 2003, Page C1 --- http://online.wsj.com/article/0,,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 Fraud Updates are at
    http://www.trinity.edu/rjensen/FraudUpdates.htm


    "The 11 Most Shocking Insider Trading Scandals Of The Past 25 Years," Business Insider, November 4, 2010 --- 
    http://www.businessinsider.com/biggest-insider-trading-scandals-2010-11#ixzz14WznUXEr

    1986: Ivan Boesky, Dennis Levine and the fall of Drexel Burnham Lambert

    2001: Martha Stewart and ImClone (I think this is less about what she did than who she was)

    2001: Art Samberg's Illegal Microsoft Trades

    2001: Rene Rivkin Convicted For Insider Trading That Netted Him Only $346

    2005: Joseph Nacchio and Qwest Communications

    2006: Livedoor and Murakami, The Enron Of Japan

    2007: Mitchel Guttenberg, David Tavdy and Erik Franklin



    Read more: http://www.businessinsider.com/biggest-insider-trading-scandals-2010-11#2007-mitchel-guttenberg-david-tavdy-and-erik-franklin-7#ixzz14X1N1ftN

    2007: Mitchel Guttenberg, David Tavdy and Erik Franklin

    2007: Randi and Christopher Collotta

    2009: The Galleon Mess

    2010: Some Very Wily Brothers - Charles and Sam Wyly And An Alleged $550 M Scheme

    2010: Insider Trading By French Doc Might Have Helped FrontPoint Avoid Huge Losses

    "Giuliani Asks Congress to Define Insider Trading," by Nathaniel C. Nash, The New York Times, April 23, 1987 --- Click Here
    http://query.nytimes.com/gst/fullpage.html?res=9B0DEFD8113FF930A15757C0A961948260&n=Top/Reference/Times Topics/People/G/Giuliani, Rudolph W.

    The United States Attorney in Manhattan, Rudolph W. Giuliani, asked Congress today to pass legislation that would define illegal insider trading, saying it would help him in prosecuting criminal cases.

    Such a definition would ''end the debate'' over what are legal and illegal practices, said Mr. Giuliani, whose office has brought almost a dozen criminal insider trading cases against participants in the current Wall Street scandal.

    Mr. Giuliani's prominence in the investigations led the White House to offer to appoint him chairman of the Securities and Exchange Commission, succeeding John S. R. Shad, who is retiring. But Mr. Giuliani declined the appointment.

    Mr. Giuliani told the Senate Banking Committee in hearings today that his office and the S.E.C. were investigating at least one case that involved criminal collusion by various investors or firms on Wall Street. He declined to provide any specifics about the case, citing his policy of not commenting on continuing investigations. An Investigation Confirmed

    ''Are you finding problems with such issues as collusion, say among arbitrage firms or other investors, in your investigations?'' asked Senator Donald W. Riegle Jr., Democrat of Michigan, who is chairman of the Banking Committee's securities subcommittee.

    After consulting with Gary G. Lynch, the head of the S.E.C.'s enforcement division, who was also testifying, Mr. Giuliani said such an investigation was being conducted by both agencies and that a public development in the case might ''be coming fairly soon.''

    Since the insider-trading scandal began last year, there has been much debate over what should be done to stop what some in Congress say is a ''systemic'' problem of insider trading and other abuses of the takeover process. Several Proposals Put Forward

    Mr. Giuliani had several recommendations:

    * In addition to increasing the size of the S.E.C. enforcement staff and that of the Justice Department to handle the growing caseload, he recommended that the penalties for insider trading be increased from the current five-year maximum to eight or 10 years.

    * He suggested that Congress send a message to the judiciary that ''prison sentences should be given in most of these cases,'' saying he strongly believed that the likelihood of spending time in prison would be the single largest deterrent to traders, ''as opposed to the organized-crime figure who factors a six-year prison term into his strategy.''

    * He recommended that a mandatory prison sentence of one to two years be given anyone convicted of obstruction of justice or perjury in an insider-trading investigation and that firms be subject to penalties for the illegal actions of their employees if the firms are found to be negligent on self-policing.

    Mr. Giuliani's call for a clear definition of insider trading comes amid considerable debate over whether such a statute would restrict, rather than preserve, the S.E.C.'s current enforcement reach.

    For years, S.E.C. officials have opposed such a definition, but Mr. Lynch said he would not oppose a definition provided it was sufficiently broad and ''neither narrows the current case law, discards the misappropriate theory or increases the evidentiary burdens on the S.E.C.''

    Both Mr. Lynch and Mr. Giuliani said they were surprised at the pervasiveness of insider trading they had discovered on Wall Street. Mr. Lynch said 20 of the 100 professionals on his staff were working on cases that have come out of current scandal; Mr. Giuliani said as much as 20 percent of his staff was involved in insider-trading cases.

    Bob Jensen's threads on greater sinners ---
    http://www.trinity.edu/rjensen/FraudRotten.htm

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

     


    From The Wall Street Journal Accounting Weekly Review on December 3, 2010

    SEC Charges Ex-Partner at Deloitte, Wife in Insider-Trading Case
    by: Jessica Holzer
    Dec 01, 2010
    Click here to view the full article on WSJ.com

    TOPICS: Ethics, Insider Trading, Public Accounting, Securities and Exchange Commission
    SUMMARY: "The Securities and Exchange Commission on Tuesday charged a former partner at Deloitte Tax LLP and his wife with passing nonpublic information about pending corporate deals to relatives in London, in an alleged multimillion-dollar insider-trading scheme uncovered jointly by U.K. and U.S. authorities... The McClellans allegedly learned about the deals through Mr. McClellan's work leading one of Deloitte's regional mergers and acquisitions teams and passed along nonpublic information about the transactions in phone calls and during visit (sic) with the [relatives]... The U.K. Financial Services Authority last week announced criminal charges... The SEC decided...to avoid duplicating efforts already being made by the U.K. authorities, the official said.... 'The McClellans might have thought that they could conceal their illegal scheme by having close relatives make illegal trades offshore. They were wrong,' the SEC's enforcement chief Robert Khuzami said in a statement. "
    CLASSROOM APPLICATION: The article can be used to discuss the temptations towards unethical behavior facing practicing accountants at all levels.
    QUESTIONS:
    1. (Advanced) What is insider information?

    2. (Advanced) Why is trading insider information illegal? Why is trading on insider information illegal?

    3. (Advanced) Of what illegal actions are a former Deloitte Tax partner and his wife accused? What entities investigated these alleged illegal activities?

    4. (Advanced) How do partners at public accounting firms have access to insider information? Do lower levels of employees of these firms have this access to insider information?

    5. (Introductory) Refer to the related article. How is it possible that regulating and prosecuting insider trading by observing market trades misses some illegal transfers of insider information?

    6. (Advanced) If Mr. McClellan is guilty of these alleged crimes, what professional code has he also violated? What are the implications of such violations for Mr. McClellan and his wife to produce a personal income in the future?

    Reviewed By: Judy Beckman, University of Rhode Island

    RELATED ARTICLES:
    Learning to Love Insider Trading --- http://online.wsj.com/article/SB10001424052748704224004574489324091790350.html
    by Donald J. Boudreaux
    Oct 24, 2009
    Page: W1

    "SEC Charges Ex-Partner at Deloitte, Wife in Insider-Trading Case," by: Jessica Holzer, The Wall Street Journal, December 1, 2010 ---
    http://online.wsj.com/article/SB10001424052748704679204575646912282141410.html?mod=djem_jiewr_AC_domainid

    The Securities and Exchange Commission on Tuesday charged a former partner at Deloitte Tax LLP and his wife with passing nonpublic information about pending corporate deals to relatives in London, in an alleged multimillion-dollar insider-trading scheme uncovered jointly by U.K. and U.S. authorities.

    The SEC, in a civil complaint filed in federal district court in Northern California, alleged that San Francisco residents Arnold McClellan and his wife Annabel alerted her sister and brother-in-law Miranda and James Sanders about at least seven pending transactions from 2006 to 2008.

    The McClellans allegedly learned about the deals through Mr. McClellan's work leading one of Deloitte's regional mergers and acquisitions teams and passed along nonpublic information about the transactions in phone calls and during visit with the Sanders, the SEC said.

    James Sanders, who co-founded a derivatives-trading firm in London, allegedly took financial positions in the acquisition targets based on the tips and shared the insider information with his colleagues at the now-defunct firm Blue Index Ltd.

    The SEC said the Sanderses netted $3 million from transactions based on the tips, half of which they shared with the McClellans. Mr. Sanders's colleagues and clients made $20 million in profits from the tips, according to the SEC.

    Annabel McClellan worked previously in the London, San Jose and San Francisco offices of Deloitte.

    The U.K. Financial Services Authority last week announced criminal charges against the Sanderses and three of James Sanders's colleagues. The Sanderses and the three other defendants in the case were first arrested by authorities in May 2009.

    An SEC official said the two regulators worked very closely on the case, which involved overseas travel by enforcement staff. The SEC decided not to charge the Sanders to avoid duplicating efforts already being made by the U.K. authorities, the official said.

    "The McClellans might have thought that they could conceal their illegal scheme by having close relatives make illegal trades offshore. They were wrong," the SEC's enforcement chief Robert Khuzami said in a statement.

    Lawyers for Arnold McClellan said he denies the SEC's charges and will vigorously contest them. "He did not trade on insider information, and there will be no evidence that he passed along any confidential information to anyone," Elliot R. Peters and Christopher Kearney of the law firm Keker & Van Nest LLP said in a statement.

    A lawyer for Annabel McClellan also said her client will fight the charges. "Ms. McClellan did not possess or receive insider information, nor did she pass it," Nanci Clarence from the law firm Clarence & Dyer in San Francisco said.

    Lawyers for the Sanderses couldn't immediately be reached for comment.

    A Deloitte spokesman said the firm is shocked by the allegations and is cooperating with the SEC's investigation.

    Mr. Sanders allegedly used derivatives instruments called "spread bet" contracts to take positions in the stocks of U.S. companies based on the information he received from the McClellans. Spread bets allow traders to make large bets on the price movements of an underlying security with relatively small investments.

    Mr. Sanders allegedly traded in the contracts quickly after he or his wife received fresh information about the prospects of a transaction occurring.

    Some of the alleged insider trading involved the planned acquisition of Kronos Inc., a Massachusetts data collection and payroll software company bought by one of McClellan's clients, San Francisco private-equity firm Hellman & Friedman LLC, in 2007.

    The SEC, in its complaint, alleged that Mr. McClellan tipped his wife off to Hellman & Friedman's planned acquisition of Kronos early in 2007.

    On Jan. 31, 2007, there was a phone call from Annabel McClellan's cellphone to the Sanders home, the SEC said. Later that day, Mr. Sanders made his first purchase of spread bet contracts tied to Kronos stock.

    Mr. Sanders increased his position in the contracts on March 12, a day after a nearly 20-minute phone call from Mr. McClellan's cell phone to Annabel's mother's home in France, where the Sanders were staying. The phone call occurred less than one hour after Mr. McClellan participated in a two-hour call with his client discussing Kronos.

    A spokesman for Hellman & Friedman declined to comment.

    Also on March 12, Blue Index sent around to its traders a document pitching Kronos stock to the firm's clients. In a recorded phone call on March 16 with his father, Mr. Sanders identified Annabel McClellan as the source of information about the timing and pricing of the Kronos acquisition and told him he had agreed to split his trading profits with her.

    "We are shocked and saddened by these allegations against our former tax partner and members of his family," Deloitte spokesman Jonathan Gandal said in a statement. "If the allegations prove to be true, they would represent serious violations of our strict and regularly communicated confidentiality policies." Deloitte is cooperating with the SEC's investigation, Mr. Gandal said.

    "Did Deloitte Compromise Independence in McClellan Insider Trading Scandal?" by Francine McKenna, Forbes, December 7, 2010 ---
    http://blogs.forbes.com/francinemckenna/2010/12/07/did-deloitte-compromise-independence-in-mcclellan-insider-trading-scandal/?boxes=Homepagechannels

    There are plenty of sexy externalities associated with the latest insider trading charges against a former Deloitte tax partner and his wife. Spicing things up: A May-December marriage, a XXX-rated website, and lots of trips between San Francisco and London to “vacation.”

    Who woulda thunk it’s the tax partners having all the fun?

    The McClellan case – their UK relatives were arrested in May 2009 and formally charged by the FSA last month – and another one against former Deloitte Vice Chairman Thomas Flanagan, settled this past August, were on the SEC’s desk at the same time. Deloitte has not been charged by the SEC in either. I doubt they will be. Deloitte played the “We were duped” card with the SEC and their clients. They sued Flanagan to save face with both.

    Continued in article

    Jensen Comment
    Deloitte's formal statements on the firm's efforts to guarantee independence and transparency are at
    http://www.cs.trinity.edu/~rjensen/temp/DeloitteTransparency Report.pdf

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

     

     

     


     

     

     


     

     




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

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

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

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

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

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

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

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

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

     

     


     

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

     

     

     

     

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