Discontent is rightfully rising over CEO pay versus performance
In fact, the boss enjoyed a hefty raise last year. The chief executives at 179 large companies that had filed proxies by last Tuesday - and had not changed leaders since last year - were paid about $9.84 million, on average, up 12 percent from 2003, according to Pearl Meyer & Partners, the compensation consultants. Surely, chief executives must have done something spectacular to justify all that, right? Well, that's not so clear. The link between rising pay and performance remained muddy - at best. Profits and stock prices are up, but at many companies they seem to reflect an improving economy rather than managerial expertise. Regardless, the better numbers set off sizable incentive payouts for bosses. With investors still smarting from the bursting of the tech bubble, the swift rebound in executive pay is touching some nerves. "The disconnect between pay and performance keeps getting worse," said Christianna Wood, senior investment officer for global equity at Calpers, the California pension fund. "Investors were really mad when pay did not come down during the three-year bear market, and we are not happy now, when companies reward executives when the stock goes up $2."
Claudia H. Deutsch, "My Big Fat C.E.O. Paycheck," The New York Times, April 3, 2005 --- http://www.nytimes.com/2005/04/03/business/yourmoney/03pay.html?
Bob Jensen's updates on fraud are at http://www.trinity.edu/rjensen/fraudUpdates.htm

From The Wall Street Journal Accounting Educators' Review on November 6, 2001
Subscribers to the Electronic Edition of the WSJ can obtain reviews in various disciplines by contacting wsjeducatorsreviews@dowjones.com 
See http://info.wsj.com/professor/ 

TITLE: Behind Shrinking Deficits: Derivatives? 
REPORTER: Silvia Ascarelli and Deborah Ball 
DATE: Nov 06, 2001 PAGE: A22 
LINK: http://interactive.wsj.com/archive/retrieve.cgi?id=SB1004996045480162960.djm  
TOPICS: Derivatives 

SUMMARY: An Italian university professor and public-debt management expert issued a report this week explaining how a European country used a swap contract to effectively receive more cash in 1997. That country is believed to be Italy although top officials deny such "window dressing" practices. 1997 was a critical year for Italy if it was to be included in the EMU (European Monetary Union) and become a part of the euro-zone. To qualify for entry, a country's deficit could not exceed 3% of gross domestic product. In 1996 Italy's deficit was 6.7% of GDP, however, the country succeeded in "slashing its budget deficit to 2.7%" in 1997. The question now is whether Italy accomplished this reduction by clamping down on waste and raising revenues or engaging in deceptive swaps usage.

QUESTIONS: 

1.) Why was the level of Italy's budget deficit so critical in 1997? How did Italy's 1997 budget deficit compare with its 1996 level?

2.) What is an interest rate swap? How can the use of swap markets decrease borrowing costs? What is a currency swap? When would firms tend to use these derivative instruments?

3.) Does the European Union condone the use of interest rate swaps by its euro-zone members as a way to manage their public debt? According to the related article, who are the biggest users of swaps in Europe? Do the U.S. and Japan use them to manage their public debt?

4.) According to the related article, interest-rate swaps now account for what proportion of the over-the-counter derivatives market? Go to the web page for the Bank of International Settlement at www.bis.org . Select Publications & Statistics then go to International Financial Statistics. Go to the Central Bank Survey for Foreign Exchange and Derivatives Market Activity. Look at the pdf version of the report, specifically Table 6. What was average daily turnover, in billions of dollars, of interest-rate swaps in April 1995? 1998? and 2001? By what percentage did interest-rate swap usage increase from 1995-1998? 1998-2001?

5.) According to the related article, how did the swaps contract allegedly used by Italy differ from a standard swaps contract? What was the "bottom line" result of this arrangement?

6.) Assume Italy did indeed use such measures to "window dress" their financial situation and gain entry into the euro-zone. What actions should be taken to prevent such loopholes in the future?

Reviewed By: 
Jacqueline Garner, Georgia State University and Univ. of Rhode Island 
Beverly Marshall, Auburn University
Peter Dadalt, Georgia State University

--- RELATED ARTICLE in the WSJ --- 

TITLE: Italy Used Complicated Swaps Contract To Deflate Budget in Bid for Euro Zone 
REPORTER: Silvia Ascarelli and Deborah Ball
ISSUE: Nov 05, 2001 
LINK: http://interactive.wsj.com/archive/retrieve.cgi?id=SB1004908712922656320.djm 

From The Wall Street Journal Accounting Educators' Review on November 8, 2001
Subscribers to the Electronic Edition of the WSJ can obtain reviews in various disciplines by contacting wsjeducatorsreviews@dowjones.com 
See http://info.wsj.com/professor/ 

TITLE: Basic Principle of Accounting Tripped Enron 
REPORTER: Jonathan Weil 
DATE: Nov 12, 2001 
PAGE: C1 
LINK: http://interactive.wsj.com/archive/retrieve.cgi?id=SB100551383153378600.djm 
TOPICS: Accounting, Auditing, Auditing Services, Auditor Independence

SUMMARY: 
Enron's financial statements have long been charged with being undecipherable; however, they are now considered to contain violations of GAAP. Enron filed documents with the SEC indicating that financial statements going back to 1997 "should not be relied upon." Questions deal with materiality and auditor independence.

QUESTIONS: 
1.) What accounting errors are reported to have been included in Enron's financial statements? Why didn't Enron's auditors require correction of these errors before the financial statements were issued?

2.) What is materiality? In hindsight, were the errors in Enron's financial statements material? Why or why not? Should the auditors have known that the errors in Enron's financial statements were material prior to their release? What defense can the auditors offer?

3.) Does Arthur Andersen provide any services to Enron in addition to the audit services? How might providing additional services to Enron affect Andersen's decision to release financial statements containing GAAP violations?

4.) The article states that Enron is one of Arthur Andersen's biggest clients. How might Enron's size have contributed to Arthur Andersen's decision to release financial statements containing GAAP violations? Discuss differences in audit risk between small and large clients. Discuss the potential affect of client firm size on auditor independence.

5.) How long has Arthur Andersen been Enron's auditor? How could their tenure as auditor contributed to Andersen's decision to release financial statements containing GAAP violations?

6.) The related article discusses how Enron's consolidation policy with respect to the JEDI and Chewco entities impacted the company's financial statements. What is meant by the phrase consolidation policy? How could a policy not to consolidate these entities help to make Enron's financial statements look better? Why would consolidating an entity result in a $396 million reduction in net income over a 4 year period? How must Enron have been accounting for investments in these entities? How could Enron support its accounting policies for these investments?

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

RELATED WSJ ARTICLES
TITLE: Enron Cuts Profit Data of 4 Years by 20% 
REPORTER: John R. Emshwiller, Rebecca Smith, Robin Sidel, and Jonathan Weil 
PAGE: A1,A3 
ISSUE: Nov 09, 2001 
LINK: http://interactive.wsj.com/archive/retrieve.cgi?id=SB1005235413422093560.djm 

TITLE: Arthur Andersen Could Face Scrutiny On Clarity of Enron Financial Reports 
REPORTER: Jonathan Weil 
DATE: Nov 05, 2001 
PAGE: C1 
LINK: http://interactive.wsj.com/archive/retrieve.cgi?id=SB1004919947649536880.djm  
TOPICS: Accounting, Auditing, Creative Accounting, Disclosure Requirements

Pricewaterhouse Coopers Is Also Being Investigated for Enron Dealings

One of my students forwarded this link.

"PwC: Sharing the Hot Seat with Andersen? PricewaterhouseCoopers' dual role at Enron and its controversial debt-shielding partnerships has congressional probers asking questions," Business Week Online , February 15, 2002 --- http://businessweek.com/bwdaily/dnflash/feb2002/nf20020215_2956.htm 

So far in the Enron scandal, Arthur Andersen has borne all the weight of the accounting profession's failures. But that's about to change. BusinessWeek has learned that congressional investigators are taking a keen interest in PricewaterhouseCoopers' role -- or roles -- in deals between Enron and its captive partnerships. A congressional source says the House Energy & Commerce Committee is collecting documents and interviewing officials at PwC.

At issue is the firm's work for both Enron and those controversial debt-shielding partnerships, set up and controlled by then-Chief Financial Officer Andrew Fastow. On two occasions -- in August, 1999, and May, 2000 -- the world's biggest accounting firm certified that Enron was getting a fair deal when it exchanged its own stock for options and notes issued by the Fastow-controlled partnerships.

Investigators plan to question the complex valuation calculations that underlie the opinions. Enron ultimately lost hundreds of millions of dollars on the deals. A PwC spokesman says the firm stands by its assessment of the deals' value at the time.

OVERLAP. Perhaps more significantly, Pricewaterhouse was working for one of the Fastow partnerships -- LJM2 Co-Investment -- at the same time it assured Enron that the Houston-based energy company was getting a fair deal in its transactions with LJM2. In effect, PwC was providing tax advice to help LJM2 structure its deal -- the first of the so-called Raptor transactions -- while the accounting firm was also advising Enron on the value of that deal.

Pricewaterhouse acknowledges the overlapping engagements but says its dual role did not violate accounting's ethics standards, which require firms to maintain a degree of objectivity in dealing with clients. The firm says the work was done by two separate teams, which did not share data. PwC's spokesman says LJM2's tax structure wasn't a factor in its opinion on the deal's valuation. And, the spokesman says, each client was informed about the other engagement. That disclosure may mean that the firm's actions were in the clear, says Stephen A. Zeff, professor of accounting at Rice University in Houston.

Lynn Turner, former chief accountant at the Securities & Exchange Commission, still has questions. "The standard [for accountants] is, you've got to be objective," says Turner, who now heads the Center for Quality Financial Reporting at Colorado State University. "The question is whether [Pricewaterhouse] met its obligation to Enron's board and shareholders to be objective when it was helping LJM2 structure the transaction it was reviewing. From a common-sense perspective, does this make sense?"

"NO RECOLLECTION." PwC's contacts on both sides of the LJM2 deal were Fastow and his subordinates. BusinessWeek could not determine whether Enron's board, the ultimate client for the fairness opinion, knew of Pricewaterhouse's dual engagements. But W. Neil Eggleston, the attorney representing Enron's outside directors, says Robert K. Jaedicke, chairman of the board's audit committee, has "no recollection of this conflict being brought to the audit committee or the board."

In any case, Capitol Hill's interest in these questions could prove embarrassing to Pricewaterhouse. The firm is charged with overseeing $130 million in assets as bankruptcy administrator of Enron's British retail arm. On Feb. 12, SunTrust Banks said it had dumped Arthur Andersen, its auditor for 60 years, in favor of PwC. And given the huge losses Enron eventually suffered on the LJM and LJM2 deals, the energy trader's shareholders may target PwC's deep pockets as a source of restitution in the biggest bankruptcy in American history.

The fairness opinions were necessary because Enron's top financial officers -- most notably Fastow, the managing partner of LJM and LJM2 -- were in charge on both sides of these transactions. Indeed, both of PwC's fairness opinions were addressed to Ben F. Glisan Jr., a Fastow subordinate who became Enron's treasurer in May, 2000. Glisan left Enron in November, 2001, after the company discovered he had invested in the first LJM partnership.

SELLING POINT. Since the deals were not arms-length negotiations between independent parties, Pricewaterhouse was called in to assure Enron's board that the company was getting fair value. Indeed, minutes from a special board meeting on June 28, 1999, show that Fastow used PwC's fairness review as a selling point for the first deal.

That complex transaction was designed to let Enron hedge against a drop in value of its investment in 5.4 million shares of Rhythms NetConnections, an Internet service provider. PwC did not work for LJM at the time it ruled on that deal's fairness for Enron. The firm valued LJM's compensation to Enron at between $164 million and $204 million.

The second deal, involving LJM2, was designed to indirectly hedge the value of other Enron investments. That deal was even more complex, and PwC's May 5, 2000, opinion does not put a dollar value on it. Instead, it says, "it is our opinion that, as of the date hereof, the financial consideration associated with the transaction is fair to the Company [Enron] from a financial point of view."

"CRISIS OF CONFIDENCE." Some documents associated with LJM2 identified Pricewaterhouse as the partnership's auditor. A December, 1999, memo prepared by Merrill Lynch to help sell a $200 million private placement of LJM2 partnership interests listed the firm as LJM2's auditor. In fact, KPMG was the auditor. The PwC spokesman says his firm didn't even bid for the LJM2 audit contract. Merrill Lynch declined to comment on the erroneous document.

The PwC spokesman acknowledges that congressional investigators have been in touch with the firm. "We are cooperating with the [Energy & Commerce] Committee," he says. On Jan. 31, the New York-based auditor said it would spin off its consulting arm, in part because of concerns that Enron has raised about the accounting profession. "We recognize that there is a crisis of confidence," spokesman David Nestor told reporters. As probers give Pricewaterhouse a closer look, that crisis could become far more real for the Big Five's No. 1.

Where is the blame for failing to protect the public by improving GAAP?

On January 10, 2002, Big Five firm Andersen notified government agencies investigating the Enron situation that in recent months members of the firm destroyed documents relating to the Enron audit. The Justice Department announced it has begun a criminal investigation of Enron Corp., and members of the Bush administration acknowledged they received early warning of the trouble facing the world's top buyer and seller of natural gas. http://www.accountingweb.com/item/68468 

An Allan Sloan quotation from Newsweek Magazine, December 10, 2001, Page 51 --- http://www.msnbc.com/news/666184.asp?0dm=-11EK 

As Enron tottered, it lost trading business. Its remaining customers began to gouge it—that’s how trading works in the real world. Don’t blame the usual suspects: stock analysts. Rather, blame Arthur Andersen, Enron’s outside auditors, who didn’t blow the whistle until too late. (Andersen says it’s far too early for me to be drawing conclusions.)
Allan Sloan, Newsweek Magazine

The Gottesdiener Law Firm, the Washington, D.C. 401(k) and pension class action law firm prosecuting the most comprehensive of the 401(k) cases pending against Enron Corporation and related defendants, added new allegations to its case today, charging Arthur Andersen of Chicago with knowingly participating in Enron's fraud on employees.
Lawsuit Seeks to Hold Andersen Accountable for Defrauding Enron Investors, Employees --- http://www.smartpros.com/x31970.xml 

Andersen was also recently in the middle of two other scandals involving Sunbeam and Waste Management, Inc. In May 2001, Andersen agreed to pay Sunbeam shareholders $110 to settle a securities fraud lawsuit. In July 2001, Andersen paid the SEC a record $7 million to settle a civil fraud complaint, which alleged that senior partners had failed to act on knowledge of improper bookkeeping at Waste Management, Inc. These "accounting irregularities" led to a $1.4 billion restatement of profits, the largest in U.S. corporate history. Andersen also agreed to pay Waste Management shareholders $20 million to settle its securities fraud claims against the firm.

A Joe Berardino quotation from The Wall Street Journal, December 4, 2001, Page A18 --- 
Mr. Berardino places most of the blame on weaknesses and failings of U.S. Generally Accepted Accounting Standards (GAAP).

Enron reminds us that the system can and must be improved.  We are prepared to do our part.
Joe Berardino,  Managing Partner and CEO of Andersen

Bob Jensen's threads on SPEs are at 
http://www.trinity.edu/rjensen//theory/00overview/speOverview.htm 

Pitt: Elevating the Accounting Profession
By: SmartPros Editorial Staff http://www.smartpros.com/x33087.xml 

Feb. 25, 2002 — Securities and Exchange Commission (former) chairman Harvey L. Pitt said in a speech Friday that the SEC needs to "ensure that auditors and accounting firms do their jobs as they were intended to be done."

Addressing securities lawyers in Washington D.C., Pitt outlined the steps the SEC intends to take to accomplish this goal.

Pitt said while "some would try to make accountants guarantors of the accuracy of corporate reports," it "is difficult and often impossible to discover frauds perpetrated with management collusion."

"The fact that no one can guarantee that fraud has not been perpetrated does not mean, however, that we cannot, or should not, improve the level and quality of audits," he added.

The SEC chief also mentioned present day accounting standards, calling them "cumbersome."

Pitt gave a brief overview of the solutions proposed by the SEC since the Enron crisis began for the accounting profession. He said the SEC is advocating changes in the Financial Accounting Standards Board, seeking greater influence over the standard-setting board and to move toward a principles-based set of accounting standards. In addition, the SEC is proposing a private-sector regulatory body, predominantly comprised of persons unaffiliated with the accounting profession, for oversight of the profession.

Pitt also said he is concerned about the current structure where managers and directors are rewarded for short-term performance. The SEC will work with Congress and other groups to improve and modernize the current disclosure and regulatory system.

"Compensation, especially in the form of stock options, can align management's interests with those of the shareholders but not if management can profit from illusory short-term gains and not suffer the consequences of subsequent restatements, the way the public does," he said.

Pitt said the agency will try to recoup money for investors in cases where executives reap the benefits from such practices.

As for dishonest managers, Pitt said the SEC is looking into making corporate officers and directors more responsive to the public's expectations and interests through clear standards of professionalism and responsibilities, and severe consequences for anyone that does not live up to his or her ficuciary obligations.

"We are proposing to Congress that we be given the power to bar egregious officers and directors from serving in similar capacities for any public company," said Pitt.

As a side note, the accounting profession's "brain drain" did not go unmentioned by Pitt. He said "the current environment -- with its scrutiny and criticism of accountants -- is unlikely to create a groundswell of interest on the part of top graduates to become auditors."

The SEC intends to help transform and elevate the performance of the profession to deal with this issue, he added.

In its first Webcast meeting, the Securities & Exchange Commission approved the issuance for comment of rule proposals on disclosures about "critical" accounting estimates. The Commission's rule proposals introduce possible requirements for qualitative disclosures about both the "critical" accounting estimates made by a company in applying its accounting policies and disclosures about the initial adoption of an accounting policy by a company. 
http://www.accountingweb.com/item/79709 

THE RELUCTANT REFORMER 

SEC Chairman Harvey Pitt now has the Herculean task of cleaning up a financial mess that has been getting worse for years. Will Pitt, a savvy conservative who's wary of regulation, crack down on corporate abuses?

Available to all readers: http://www.businessweek.com/premium/content/02_12/b3775001.htm?c=bwinsidermar15&n=link60&t=email 

Few SEC chiefs have come into office with the qualifications Pitt brings. He knows both the agency and the industries it regulates intimately. In a quarter-century of representing financial-fraud defendants he has been exposed to nearly every known form of chicanery. The Reluctant Reformer has enormous potential to end the epidemic of financial abuse plaguing Corporate America. And when it comes to getting things done, there's a chance that Pitt's conciliatory style could achieve much more than Levitt's saber-rattling.

Will this historic moment in American business produce a historic reformer? Or will Pitt succumb to the pressures--from his party, from Wall Street, and from his own ideology--and devote himself to little more than calming the troubled political waters around his President? Super-lawyer Pitt likes to say that since he took the helm at the SEC, he now works for "the most wonderful client of all--the American investor." It's time for him to deliver for that client as he has for so many others before.

Note:  Harvey Pitt resigned from the SEC following allegations that he was aiding large accounting firms in stacking the new Public Company Accounting Oversight Board (PCAOB) created in the Sarbanes-Oxley Act of 2002.  

News Release from Andersen --- http://andersen.com/website.nsf/content/MediaCenterNewsReleaseArchiveAndersenStatement011402!OpenDocument 

Statement of Andersen — January 14, 2002

As the firm has repeatedly stated, Andersen is committed to getting the facts, and taking appropriate actions in the Enron matter. We are moving as quickly as possible to determine all the facts.

The author of the October 12 e-mail which has been widely reported on is Ms. Nancy Temple, an in-house Andersen lawyer. Her Oct. 12 email, which was sent to Andersen partner Michael Odom, the risk management partner responsible for the Houston office, reads "Mike - It might be useful to consider reminding the engagement team of our documentation and retention policy. It will be helpful to make sure that we have complied with the policy. Let me know if you have any questions" and includes a link to the firm's policy on the Andersen internal website. The firm policy linked to her email prohibits document destruction under some circumstances and authorizes it under other circumstances.

At the time Ms. Temple sent her e-mail, work on accounting issues for Enron's third quarter was in progress. Ms. Temple has told the firm that it was this current uncompleted work that she was referring to in her email and that she never told the audit team that they should destroy documents for past audit work that was already completed. Mr. Odom has told Andersen that when he received Ms. Temple's email, he forwarded it to David Duncan, the Enron engagement partner, with the comment "More help" meaning that Ms. Temple's email was reminding them of the existing policy. It is important to recognize that the release of these communications are not a representation that there were no inappropriate actions. There were other communications. We are continuing our review and we hope to be able to announce progress in that regard shortly.

Attached are copies of the two emails and a copy of the Andersen records retention policy.

The following files are available for download in PDF format:

Copy of two e-mails (15k, 1 page)

Policy statement: Client Engagement Information - Organization, Retention and Destruction, Statement No. 760 (140k, 26 pages)

Policy statement - Practice Administration: Notification of Threatened or Actual Litigation, Governmental or Professional Investigations, Receipt of a Subpoena, or Other Requests for Documents or Testimony (Formal or Informal), Statement No. 780 (106k, 8 pages)

Bob Jensen's Commentary on the Above Message From the CEO of Andersen
     (The Most Difficult Message That I Have Perhaps Ever Written!)
     This is followed by replies from other accounting educators.

The Two Faces of Large Public Accounting Firms

I did not sleep a wink on the night of December 4, 2001.  The cowardly side of me kept saying "Don't do it Bob."  And the academic side of me said "Somebody has to do it Bob."  Before my courage won out at 4:00 a.m., I started to write this module.

Let me begin by stating that my loyalty to virtually all public accounting firms, especially large accounting firms, has been steadfast and true for over 30 years of my life as an accounting professor.  I am amazed at the wonderful things these firms have done in hiring our graduates and in providing many other kinds of support for our education programs.  In practice, these firms have generally performed their auditing and consulting services with high competence and high integrity.

I view a large public accounting firm like I view a large hospital.  Two major tasks of a hospital are to help physicians do their jobs better and to protect the public against incompetent and maverick physicians.  Two major tasks of the public accounting firms on audits is to help corporate executives account better and to protect the public from incompetent and maverick corporate executives.  Day in and day out, hospitals and public accounting firms do their jobs wonderfully even though it never gets reported in the media.  But the occasional failings of the systems make headlines and, in the U.S., the trial lawyers commence to circle over some poor dead or dying carcass. 

When the plaintiff's vultures are hovering, the defendant's attorneys generally advise clients to never say a word.  I fully expected Enron's auditors to remain silent.  The auditing firm that certified Enron's financial statement was the AA firm that is now called Andersen and for most of its life was previously called Arthur Andersen or just AA.  Aside from an occasional failing, the AA firm over the years has been one of the most respected among all the auditing firms.  

It therefore shocked me when the Managing Partner and CEO of Andersen, Joe Beradino, wrote a piece called "Enron:  A Wake-Up Call" in the December 4 edition of The Wall Street Journal (Page A18).  That article opened up my long-standing criticism of integrity in large public accounting firms.  I will focus upon the main defense raised by Mr. Beradono.  His main defense is that when failing to serve the best public interests, the failings are more in GAAP than in the auditors who certify that financial statements are/were fairly prepared under GAAP.  Mr. Beradino's places most of the blame on the failure of GAAP to allow Off-Balance Sheet Financing (OBSF).  In the cited article, Mr Beradono states:

Like many companies today, Enron used sophisticated financing vehicles known as Special Purpose Entities (SPEs) and other off-balance-sheet structures.  Such vehicles permit companies, like Enron, to increase leverage without having to report debt on their balance sheet.  Wall Street has helped companies raise billions with these structured financings, which are well known to analysts and investors.

As the rules stand today, sponsoring companies can keep the assets and liabilities of SPEs off their consolidated financial statements, even though they retain a majority of the related risks and rewards.  Basing the accounting rules on a risk/reward concept would give investors more information about the consolidated entity's financial position by having more of the assets and liabilities that are at risk on the balance sheet ...

There is one failing among virtually all large firms that I've found particularly disturbing over the years, but I've not stuck my neck out until now.  In a nutshell, the problem is that large firms often come down squarely on both sides of a controversial issue, sometimes preaching virtue but not always practicing what is preached.  The firm of Andersen is a good case in point.

1. On the good news side, Andersen has generally had an executive near the top writing papers and making speeches on how to really improve GAAP.  For example, I have the utmost respect for Art Wyatt.   Dr. Wyatt (better known as Art) is a former accounting professor who, for nearly 20 years, served as the Arthur Andersen's leading executive on GAAP and efforts to improve GAAP.  Dr. Wyatt's Accounting Hall of Fame tribute is at http://www.uif.uillinois.edu/public/InvestingIL/issue27/art10.htm 
   
   Nobody has probably written better articles lamenting off-balance sheet financing than Art Wyatt while he was at Andersen.  I always make my accounting theory students read  "Getting It Off the Balance Sheet," by Richard Dieter and Arthur R. Wyatt, Financial Executive, January 1980, pp. 44-48.  In that article, Dieter and Wyatt provide a long listing of OBSF ploys and criticize GAAP for allowing too much in the way of OBSF.  I like to assign this article to students, because I can then point to the great progress the Financial Accounting Standards Board (FASB) made in ending many of the OBSF ploys since 1980.  The problem is that the finance industry keeps inventing ever new and ever more complex ploys such as derivative instruments and structured financings that I am certain Art Wyatt wishes that GAAP would correct in terms of not keeping debt of the balance sheet.  It is analogous to plugging bursting dike.  You get one whole plugged and ten more open up!
   
    

2. On the bad news side, Andersen and other big accounting firms, under intense pressure from large clients, have sometimes taken the side of the clients at the expense of the public's best interest.  They sometimes dropped laser-guided bombs on efforts of the leaders like Dr. Wyatt, the FASB, the IASB, and the SEC to end OBSF ploys.  On occasion, the firm's leaders initially came out in in theoretical favor of ending an OBSF ploy and later reversed position after listening to the displeasures of their clients.  My best example here is the initial position take by Andersen's leaders to support the very laudable FASB effort to book vested employee stock compensation as income statement expenses and balance sheet liabilities.  Apparently, however, clients bent the ear of Andersen and led the firm to change its position.  Andersen dropped a bomb on the beleaguered FASB by widely circulating a pamphlet entitled "Accounting for Stock-Based Compensation" in August of 1993.  In that pamphlet under the category "Arthur Andersen Views," the official position turned against booking of employee stock compensation:

Quote From "Accounting for Stock-Based Compensation" in August of 1993.

Arthur Andersen Views In December 1992, in a letter to the FASB, we expressed the view that the FASB should not be addressing the stock compensation issue and that continuation of today's accounting is acceptable.  We believe it is in the best interests of the public, the financial community, and the FASB itself for the Board to address those issues that would have a significant impact on improving the relevance and usefulness of financial reporting.  In our view, employers' accounting for stock options and other stock compensation plans does not meet that test.  Despite our opposition, and the opposition of hundreds of others, the FASB decided to complete their deliberations and issue an ED.  We believe the FASB's time and efforts could have been better spent on more important projects.

I can't decide whether it is better to describe the above reply haughty or snotty --- I think I will call it both.

The ill-fated ED that would have forced booking of employee stock options never became a standard because of the tough fight put up against it my large accounting firms, their clients, and the U.S. Congress and Senate.

Returning to Joe Beradino's most current lament of how Special Purpose Entities (SPEs) are not accounted for properly under GAAP, we must beg the question regarding what efforts Andersen has made over the years to get the FASB, the IASB, and the SEC end off-balance-sheet financing with SPEs.  Andersen has made a lot of revenue consulting with clients on how to enter into SPEs and, thereby, take tax and reporting advantages.  Andersen in fact formed a New York Structured Finance Group to assist clients in this regard.  See http://www.securitization.net/knowledgebank/accounting/index.asp 

Joe Beradino wrote the following:   "Like many companies today, Enron used sophisticated financing vehicles known as Special Purpose Entities (SPEs) and other off-balance-sheet structures."  The auditing firm, Andersen, that he heads even publishes a journal called Structured Thoughts advising clients on how to enter into and manage structured financings such as SPEs.  For example, the January 5, 2001 issue is at http://www.securitization.net/pdf/aa_asset.pdf 

I will close this with a quotation from a former Chief Accountant of the Securities and Exchange Commission.

Quote From a Chief Accountant of the SEC
(Well Over a Year Before the Extensive Use of SPEs by Enron Became Headline News.)

So what does this information tell us? It tells us that average Americans today, more than ever before, are willing to place their hard earned savings and their trust in the U.S. capital markets. They are willing to do so because those markets provide them with greater returns and liquidity than any other markets in the world and because they have confidence in the integrity of those markets. That confidence is derived from a financial reporting and disclosure system that has no peer. A system built by those who have served the public proudly at organizations such as the Financial Accounting Standards Board ("FASB") and its predecessors, the stock exchanges, the auditing firms and the Securities and Exchange Commission ("SEC" or "Commission"). People with names like J.P. Morgan, William O. Douglas, Joseph Kennedy, and in our profession, names like Spacek, Haskins, Touche, Andersen, and Montgomery.   But again, improvements can and should be made. First, it has taken too long for some projects to yield results necessary for high quality transparency for investors. For example, in the mid 1970's the Commission asked the FASB to address the issue of whether certain equity instruments like mandatorily redeemable preferred stock, are a liability or equity? Investors are still waiting today for an answer. In 1982, the FASB undertook a project on consolidation. One of my sons who was born that year has since graduated from high school. In the meantime, investors are still waiting for an answer, especially for structures, such as special purpose entities (SPEs) that have been specifically designed with the aid of the accounting profession to reduce transparency to investors. If we in the public sector and investors are to look first to the private sector we should have the right to expect timely resolution of important issues. "The State of Financial Reporting Today: An Unfinished Chapter" Remarks by Lynn E. Turner,   Chief Accountant U.S. Securities & Exchange Commission,  May 31, 2001 --- http://www.sec.gov/news/speech/spch496.htm

 

The research question of interest to me is whether the large accounting firms, including Andersen, have been following the same course of coming down on both sides of a controversial issue.  Lynn Turner's excellent quote above stresses that SPEs have been a known and controversial accounting issue for 20 years.  The head of the firm that audited Enron asserts that the public was mislead by Enron's certified financial statements largely because of bad accounting for SPEs.

Thus I would like discover evidence that Andersen and the other large accounting firms have actively assisted the FASB, the IASB, and the SEC in trying to bring SPE debt onto consolidated balance sheets or whether they have actively resisted such attempts because of pressure from large clients like Enron who actively resisted booking of enormous SPE debt in consolidated financial statements.

One thing is certain.  The time was never better to end bad SPE accounting and bad accounting for structured financing in general before Lynn Turner's son becomes a grandfather.

However, SPEs are not bad per se.  You can read more about SPE uses and abuses at 
    http://www.trinity.edu/rjensen//theory/00overview/speOverview.htm 
 

Leonard Spacek was the most famous and most controversial of all the managing partners of the accounting firm of Arthur Andersen. It is really amazing to juxtapose what Spacek advocated in 1958 with the troubles that his firm having in the past decade or more.

In the link below, I quote a long passage from a 1958 speech by Leonard Spacek. I think this speech portrays the decline in professionalism in public accountancy. What would Spacek say today if he had to testify before Congress in the Enron case.

What I am proposing today is the need for both an accounting court to resolve disputes between auditors and clients along with something something like an investigative body that is to discover serious mistakes in the audit, including being a sounding board for whistle blowing. Spacek envisioned the "court" to be more like the FASB. My view extends this concept to be more like the accounting court in Holland combined with an investigative branch outside the SEC.

Ernst & Young changes its mind
Firm reported to reverse its stance on how companies account for stock options. 
CNN Money, February 14, 2003 --- http://money.cnn.com/2003/02/14/news/companies/ernstandyoung.reut/index.htm 
Also see Bob Jensen's threads on this topic at http://www.trinity.edu/rjensen/theory/sfas123/jensen01.htm 

"Tax-Shelter Sellers Lie Low For Now, Wait Out a Storm," by Cassel Bryan-Low and John D. McKinnon, The Wall Street Journal, February 14, 2003, Page C1 --- http://online.wsj.com/article/0,,SB1045188334874902183,00.html?mod=todays%5Fus%5Fmoneyfront%5Fhs 

With the Internal Revenue Service, Congress and even their own clients on their case, tax-shelter promoters are changing their act to survive.

Using names that evoke an aggressive Arnold Schwarzenegger movie is undesirable right now. Which may be why accounting firm Deloitte & Touche LLP's corporate tax-shelter group has ditched its informal name, Predator, and morphed into a new group with a safer, if duller, name: "Comprehensive Tax Solutions."

KPMG LLP has taken a similar tack. Last year, it disbanded some teams that pitched aggressive strategies -- including some named after the Shakespearean plays "The Tempest" and "Othello" -- to large corporate clients and their top executives. The firm also created a separate chain of command for partners dealing with technical tax issues; those partners handling ethical and regulatory issues report to different bosses.

Shelter promoters also have largely abandoned their strategy of selling one-size-fits-all tax-avoidance plans to hundreds or even thousands of corporate and individual clients. IRS investigators targeted these plans, especially in the past two years, as the government began requiring firms to disclose lists of their clients for abusive tax shelters. Other shelter firms are going down-market, pitching tax-avoidance plans to real-estate agents and car dealers, rather than the super-rich. Demand for tax-avoidance schemes of all kinds is bound to rebound sharply, promoters figure, especially when the stock market rebounds.

For now, though, some traditional corporate clients and wealthy individuals are getting nervous about using aggressive tax-avoidance plans. The IRS cracked down last year to try to force several big accounting firms -- KPMG, BDO Seidman LLP and Arthur Andersen LLP, among others -- to hand over documents about the tax shelters their corporate clients were using. The travails of Sprint Corp.'s two top executives, who are being forced out for using a complicated tax-avoidance scheme, is the latest big blow to tax shelters.

This week, about 100 financial executives gathered for cocktails at a hotel in Sprint's hometown of Kansas City, Kan. Milling outside the dining room, the discussion quickly turned to tax shelters. The debate: Should executives turn to their company's outside auditors for personal tax strategies, given that executives are pitted against the auditor if the tax strategies turn out to be faulty? The risk for executives lies not only in getting stuck with back taxes and penalties, but, as the Sprint case demonstrates, a severely damaged personal reputation.

Some large accounting firms once earned as much as $100 million or more in revenue annually from their shelter-consulting business at the market's peak around 2000. Now, the revenues are in sharp decline, partners at Big Four firms say. In some cases, business from wealthy individuals has dropped about 75% from a few years ago. Business from corporate clients has suffered less, because accounting firms have been able to persuade customers to buy customized, more costly, advice.

Ernst & Young LLP says a group there that had sold tax strategies for wealthy individuals has been shut. E&Y does continue to sell tax strategies to corporate clients, but, a spokesman says: "We don't offer off-the-shelf strategies that don't have a business purpose."

Among the downsides of tax-shelter work: litigation risk. Law firm Brown & Wood LLP, which is now a part of Sidley Austin Brown & Wood LLP, is a defendant in two lawsuits filed in December by disgruntled clients, who allege the law firm helped accountants sell bogus tax strategies by providing legal opinions that the transactions were proper. The suits, one filed in federal court in Manhattan and one in state court in North Carolina, contend that the law firm knew or should have known the tax strategies weren't legitimate.

Continued at http://online.wsj.com/article/0,,SB1045188334874902183,00.html?mod=todays%5Fus%5Fmoneyfront%5Fhs 

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

Jensen Note:  Accounting educators might ask their students why performance looked better.  
Hint:  See the article and see one of Bob Jensen's former examinations at 
http://www.cs.trinity.edu/~rjensen/Exams/5341sp02/exam02/Exam02VersionA.htm 

The following is an important article in accounting. It shows how something students may think is a minor deal can have an enormous impact on reported performances of corporations.

It also illustrates the enormous ramifications of controversial and complex tax shelters invented by tax advisors from the same firm (in this case E&Y) that also audits the financial statements. It appears that one of the legacies of the not-so-lame-duck Harvey Pitt who's still at the SEC is to continue to allow accounting firms to both conduct audits and do consulting on complex tax shelters for the client. Is this an example of consulting that should continue to be allowed?

SPRINT RECEIVED big tax benefits in 1999 and 2000 from the exercise of stock options by its executives. The exercises also made the telecom concern's performance look better. Sprint President Ronald LeMay is negotiating for a larger severance package.
Ken Brown and Rebecca Blumenstein, The Wall Street Journal, February 13, 2002 --- http://online.wsj.com/article/0,,SB104510738662209143,00.html?mod=technology_main_whats_news 

NEW YORK -- While Sprint Corp.'s two top executives have lost their jobs and face financial ruin over the use of tax shelters on their stock-option gains, the company itself received big tax benefits from the options these and other Sprint executives exercised.

Regulatory filings show that Sprint had a tax benefit of $424 million in 2000 and $254 million in 1999 stemming from its employees' taxable gains of about $1.9 billion from the exercise of options in those two years. Sprint, which was burning through cash at the time as the telecommunications market bubble burst, had virtually no tax bill in 1999 and 2000, because of sizable business losses. But the Overland Park, Kan., company was able to carry the tax savings forward to offset taxes in future years.

Under the complicated accounting and tax rules that govern stock options, the exercises also made Sprint's performance look better by boosting the company's net asset value, an important measure of a company's financial health.

The dilemma facing Sprint and its two top executives over whether to reverse the options shows how the executives' personal financial situation had become inextricably intertwined with the company's interests. In Sprint's case, the financial interests of the company and its top two executives had diverged. Both were using the same tax adviser, Ernst & Young LLP. The matter has renewed debate about whether such dual use of an auditing firm creates auditor-independence issues that can hurt shareholders.

Stock-option exercises brought windfalls to Sprint employees as the company's shares rose in anticipation of a 1999 planned merger with WorldCom Inc., which later was blocked by regulators.

Sprint Chairman and Chief Executive William T. Esrey and President Ronald LeMay sought to shield their gains from taxes using a sophisticated tax strategy offered by Ernst & Young. That tax shelter now is under scrutiny by the Internal Revenue Service. If it's disallowed, the executives would owe tens of millions of dollars in back taxes and interest.

Sprint recently dismissed the two men and intends to name Gary Forsee, vice chairman of BellSouth Corp., to succeed Mr. Esrey. Messrs. Esrey and LeMay are now trying to negotiate larger severance packages with the company because of their unexpected dismissals. (See related article.)

Sprint, like other companies, was allowed to take as a federal income-tax deduction the value of gains reaped from all those stock options that employees exercised during the year. Between 1999 and 2000, Mr. LeMay exercised options with a taxable gain of $149 million, while Mr. Esrey exercised options with a taxable gain of $138 million. Assuming the standard 35% corporate tax rate on the $287 million in options gains, the executives would have helped the company realize $100 million of tax savings in those two years.

If the company had agreed to unwind the transactions -- by buying back the shares and issuing new options -- the $100 million in savings would have been wiped out and the company would have had to record a $100 million compensation expense, which would have cut earnings.

"They would have had a large compensation expense immediately at the moment of recision equal to the tax benefit they would have foregone," says Robert Willens, Lehman Brothers tax-and-accounting analyst. "So there was no way they were going to do that."

The tax savings to Sprint revealed in the filings shed light on why the company opted not to unwind the now-controversial options exercises of Messrs. Esrey and LeMay. The executives wanted to unwind the options at the end of 2000 after learning that the IRS was frowning on the tax shelters they had used and the value of Sprint's stock had fallen markedly. However, the conditions the SEC put on such a move would have been expensive for the company. The subject wasn't discussed by the board of directors, according to people familiar with the situation. It isn't clear what role Messrs. Esrey and LeMay played in making the decision not to unwind the options.

Many tax-law specialists believe the IRS will rule against the complicated shelters, which the two executives have said could spell their financial ruin. Because Sprint's stock price collapsed after Sprint's planned merger with WorldCom was rejected by regulators in June 2000, the executives were left holding shares worth far less than the tax bill they could potentially face if their shelters are disallowed by the IRS.

If the telecommunications company had unwound the transactions, Sprint would have had to restate and lower its 1999 profits. The company could have seen its earnings pushed lower for years to come and might have been forced to refile its back taxes at a time when Sprint's cash was limited, according to tax experts.

The large companywide burst of options activity demonstrates just what a frenzy was taking place within Sprint in the wake of its proposed $129 billion merger with WorldCom. In 1998, Sprint deducted only $49 million on its federal taxes from employees exercising their stock options. That swelled to $424 million in 2000.

The push to exercise options in 2000 was intensified by Sprint's controversial decision to accelerate the timing of when millions of options vested to the date of shareholder approval of the WorldCom deal -- not when the deal was approved by regulators. The deal ultimately was approved by shareholders and rejected by regulators. In the meanwhile, many executives took advantage of their options windfalls, while common shareholders got saddled with the falling stock price.

Continued in the article.

 

Jensen Note:  Accounting educators might ask their students why performance looked better.  
Hint:  See the article and see one of Bob Jensen's former examinations at 
http://www.cs.trinity.edu/~rjensen/Exams/5341sp02/exam02/Exam02VersionA.htm 

Also note http://www.trinity.edu/rjensen/theory/sfas123/jensen01.htm 

Februrary 13, 2003 reply from Ed Scribner

Paragraph on p. A17 of Wall Street Journal, Tuesday, February 11, 2003, about E&Y's advice to Sprint executives William Esrey and Ronald LeMay:

Along with selling the executives on the tax shelters, Ernst & Young advised them against putting Sprint shares aside to pay for potential taxes and to claim thousands of exemptions so they would owe virtually no taxes. The accountant advised Mr. LeMay to claim more than 578,000 [sic] exemptions on his 2000 federal tax W4 form, for example. 

Can this be for real? 

Ed Scribner 
Department of Accounting & Business Computer Systems 
Box 30001/MSC 3DH New Mexico State University 
Las Cruces, NM, USA 88003-8001

February 13, 2003 reply from Todd Boyle [tboyle@ROSEHILL.NET] 

Of course, they aren't binding and don't persuade the IRS or anybody else, very much. The main effect of "Comfort Letters" has been that they reduce the likelihood of penalties on the taxpayer. As such, the accounting profession has a printing press, for printing money. The "audit lottery" already exhibits much lower taxes, statistically. Together with "Comfort Letters" the whole arrangement makes the CPA a key enabler of financial crime, an unacceptable moral hazard.

Legislation is needed (A) Whenever a "Comfort Letter exists, if penalties otherwise applicable on the taxpayer are abated, those penalties shall be born by the author of the "Comfort Letter"

and (B) Whenever such determination is made that a "Comfort Letter" defense was successfully raised by a taxpayer, the author of the "Comfort Letter" shall be required to provide IRS with a list of all clients and TINs, to whom that position in the "Comfort Letter" was explained or communicated."

Todd Boyle CPA - Kirkland WA

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

My second Philadelphia Inquirer Interview
February 24, 2002 Message from James Borden [james.borden@VILLANOVA.EDU] 

Here is a brief excerpt from an article entitled "Accounting Firms demand change, then they resist it".

...Accountants should have been championing change, not fighting it, several accounting professors said. "They say they're for motherhood, but they're selling prostitution," said Bob Jensen, an accounting professor at Trinity University in San Antonio, Texas.

You can read the full article at http://www.philly.com/mld/philly/business/2736217.htm 

Be aware that articles only stay freely available for about a week at the Philadelphia Inquirer.

Jim Borden Villanova University

Also see http://www.trinity.edu/rjensen/FraudPhiladelphiaInquirere022402.htm 

My first Philadelphia Inquirer Interview --- http://www.trinity.edu/rjensen/philadelphia_inquirer.htm 
"As Enron scandal continues to unfold, more intriguing elements come to light," by Miriam Hill, Philadelphia Inquirer, January 23, 2002

A February 24, 2002 message from Elliot Kamlet [ekamlet@BINGHAMTON.EDU] 

When the FASB tried to force FAS 133 (fair value), at least one, maybe two bills were introduced in congress to bar the FASB from doing so. Financial executives, fearful of the impact of stock options on the bottom line and fearful of what action the IRS might take if the options were to be valued at fair value, used an incredible amount of pressure to make sure this method was not adopted. As a result, it is only recommended. If you read Coca Cola footnote 12, it does give the fair value measured by Black Scholes.

APB 25 and FAS 133 are applicable. So Coca Cola using APB 25 values options at the difference between the exercise price and the market price (generally -0-). But Boeing uses FAS 133, the recommended method of using an option pricing model, such as Black-Scholes, to value options issued at fair value. FAS 133 is not required, only recommended.

Auditors would need to be competent to evaluate the fair value valuation if the total is material. However, they could just hire their own expert to meet the requirement.

Elliot Kamlet

On January 11, 2002 Ruth Bender, Cranfield School of Management wrote the following:

On a related subject, the front page of the UK journal Accountancy Age yesterday was full of outraged comments from partners of the other Big 5 firms. However, what worried me was what it was that was outraging  them. 

 It wasn't that Andersen made the 'errors of judgement' - but that Bernadino > had admitted them in public.

From Time Magazine on January 14, 2002.

Just four days before Enron disclosed a stunning $618 million loss for the third quarter—its first public disclosure of its financial woes—workers who audited the company's books for Arthur Andersen, the big accounting firm, received an extraordinary instruction from one of the company's lawyers. Congressional investigators tell Time that the Oct. 12 memo directed workers to destroy all audit material, except for the most basic "work papers." And that's what they did, over a period of several weeks. As a result, FBI investigators, congressional probers and workers suing the company for lost retirement savings will be denied thousands of e-mails and other electronic and paper files that could have helped illuminate the actions and motivations of Enron executives involved in what now is the biggest bankruptcy in U.S. history.

Supervisors at Arthur Andersen repeatedly reminded their employees of the document-destruction memo in the weeks leading up to the first Security and Exchange Commission subpoenas that were issued on Nov. 8. And the firm declines to rule out the possibility that some destruction continued even after that date. Its workers had destroyed "a significant but undetermined number" of documents related to Enron, the accounting firm acknowledged in a terse public statement last Thursday. But it did not reveal that the destruction orders came in the Oct. 12 memo. Sources close to Arthur Andersen confirm the basic contents of the memo, but spokesman David Tabolt said it would be "inappropriate" to discuss it until the company completes its own review of the explosive issue.

Though there are no firm rules on how long accounting firms must retain documents, most hold on to a wide range of them for several years. Any deliberate destruction of documents subject to subpoena is illegal. In Arthur Andersen's dealings with the documents related to Enron, "the mind-set seemed to be, If not required to keep it, then get rid of it," says Ken Johnson, spokesman for the House Energy and Commerce Committee, whose investigators first got wind of the Oct. 12 memo and which is pursuing one of half a dozen investigations of Enron. "Anyone who destroyed records out of stupidity should be fired," said committee chairman Billy Tauzin, a Louisiana Republican. "Anyone who destroyed records to try to circumvent our investigation should be prosecuted."

The accounting for a global trading company like Enron is mind-numbingly complex. But it's crucial to learning how the company fell so far so fast, taking with it the jobs and pension savings of thousands of workers and inflicting losses on millions of individual investors. At the heart of Enron's demise was the creation of partnerships with shell companies, many with names like Chewco and JEDI, inspired by Star Wars characters. These shell companies, run by Enron executives who profited richly from them, allowed Enron to keep hundreds of millions of dollars in debt off its books. But once stock analysts and financial journalists heard about these arrangements, investors began to lose confidence in the company's finances. The results: a run on the stock, lowered credit ratings and insolvency.

Shredded evidence is only one of the issues that will get close scrutiny in the Enron case. The U.S. Justice Department announced last week that it was creating a task force, staffed with experts on complex financial crimes, to pursue a full criminal investigation. But the country was quickly reminded of the pervasive reach of Enron and its executives—the biggest contributors to the Presidential campaign of George W. Bush—when U.S. Attorney General John Ashcroft had to recuse himself from the probe because he had received $57,499 in campaign cash from Enron for his failed 2000 Senate re-election bid in Missouri. Then the entire office of the U.S. Attorney in Houston recused itself because too many of its prosecutors had personal ties to Enron executives—or to angry workers who have been fired or have seen their life savings disappear.

Texas attorney general John Cornyn, who launched an investigation in December into 401(k) losses at Enron and possible tax liabilities owed to Texas, recused himself because since 1997 he has accepted $158,000 in campaign contributions from the company. "I know some of the Enron execs, and there has been contact, but there was no warning," he says of the collapse.

Bush told reporters that he had not talked with Enron CEO Kenneth L. Lay about the company's woes. But the White House later acknowledged that Lay, a longtime friend of Bush's, had lobbied Commerce Secretary Don Evans and Treasury Secretary Paul O'Neill. Lay called O'Neill to inform him of Enron's shaky finances and to warn that because of the company's key role in energy markets, its collapse could send tremors through the whole economy. Lay compared Enron to Long-Term Capital Management, a big hedge fund whose near collapse in 1998 required a bailout organized by the Federal Reserve Board. He asked Evans whether the Administration might do something to help Enron maintain its credit rating. Both men declined to help.

An O'Neill deputy, Peter Fisher, got similar calls from Enron's president and from Robert Rubin, the former Treasury Secretary who now serves as a top executive at Citigroup, which had at least $800 million in exposure to Enron through loans and insurance policies. Fisher—who had helped organize the LTCM bailout—judged that Enron's slide didn't pose the same dangers to the financial system and advised O'Neill against any bailout or intervention with lenders or credit-rating agencies.

On the evidence to date, the Bush Administration would seem to have admirably rebuffed pleas for favors from its most generous business supporter. But it didn't tell that story very effectively—encouraging speculation that it has something to hide. Democrats in Congress, frustrated by Bush's soaring popularity and their own inability to move pet legislation through Congress, smelled a chance to link Bush and his party to the richest tale of greed, self-dealing and political access since junk-bond king Michael Milken was jailed in 1991. That's just what the President, hoping to convert momentum from his war on terrorism to the war on recession, desperately wants to avoid. The fallout will swing on the following key questions:

Was a crime committed?

The justice investigation will be overseen in Washington by a seasoned hand, Josh Hochberg, head of the fraud section and the first to listen to the FBI tape of Linda Tripp and Monica Lewinsky in the days leading to the case against President Clinton. The probe will address a wide range of questions: Were Enron's partnerships with shell corporations designed to hide its liabilities and mislead investors? Was evidence intentionally or negligently destroyed? Did Enron executives' political contributions and the access that the contributions won them result in any special favors? Did Enron executives know the company was sinking as they sold $1.1 billion in stock while encouraging employees and other investors to keep buying?

"It's not hard to come up with a scenario for indictment here," says John Coffee, professor of corporate law at Columbia University. "Enough of the facts are already known to know that there is a high prospect of securities-fraud charges against both Enron and some of its officers." He adds that "once you've set up a task force this large, involving attorneys from Washington, New York and probably California, history shows the likelihood is they will find something indictable."

Enron has already acknowledged that it overstated its income for more than four years. The question is whether this was the result of negligence or an intent to defraud. Securities fraud requires a willful intent to deceive. It doesn't look good, Coffee says, that key Enron executives were selling stock shortly before the company announced a restatement of earnings.

As for Arthur Andersen, criminal charges could result if it can be shown that its executives ordered the destruction of documents while being aware of the existence of a subpoena for them. A likely ploy will be for prosecutors to target the auditors, hoping to turn them into witnesses against Enron. Says Coffee: "If the auditors can offer testimony, that would be the most damaging testimony imaginable."

http://www.time.com/time/business/article/0,8599,193520,00.html 

The Time Magazine link above is at http://www.time.com/time/business/article/0,8599,193520,00.html 

That article provides links to  learning about "Lessons From the Enron Collapse" and why the Andersen liability is so unlike virtually all previous malpractice suits.

Lessons from the Enron Collapse Part I - Old line partners wanted ... http://www.accountingmalpractice.com/res/articles/enron-1.pdf 
 

Part II - Why Andersen is so exposed ... http://www.accountingmalpractice.com/res/articles/enron-2.pdf 
 

Part III - An independence dilemma http://www.accountingmalpractice.com/res/articles/enron-3.pdf 
 

Main link --- http://www.accountingmalpractice.com. 

Dingell Takes Pitt to Task in Wake Of Enron Debacle; Full Investigation Sought --- http://www.trinity.edu/rjensen//theory/00overview/speOverview.htm 

Bob Jensen's threads on SPEs are at 
http://www.trinity.edu/rjensen//theory/00overview/speOverview.htm 

"The Big Five Need to Factor in Investors," Business Week, December 24, 2001, Page 32 --- http://www.businessweek.com/ (not free to download for non-subscribers)

At issue are so-called special-purpose entities (SPEs), such as Chewco and JEDI partnerships Enron used to get assets like power plants off its books.  Under standard accounting, a company can spin off assets --- an the related debts --- to an SPE if an outside investor puts up capital worth at least 3% of the SPEs total value.  

Three of Enron's partnerships didn't meet the test --- a fact auditors Arthur Andersen LLP missed.  On Dec. 12, Andersen CEO Joseph F. Berardino told the House Financial Services Committee his accountants erred in calculating one partnership's value.  On others, he says, Enron withheld information from its auditors:  The outside investor put up 3%, but Enron cut a side deal to cover half of that with its own cash.  Enron denies it withheld any information.

Does that absolve Andersen?  Hardly.  Auditors are supposed to uncover secret deals, not let them slide.  Critics fear the New Economy emphasis means auditors will do even less probing.

The 3% rule for SPEs is also too lax.

To Andersen's credit, it has long advocated a tighter rule.  But that would crimp the Big Five's clients --- companies and Wall Street.  Accountants have helped stall changes.  

Enron's collapse may finally breat that logjam.  Like it or not, the Big Five must accept new rules that give investors a clearer picture of what risks companies run with SPEs.

The rest of the article is on Page 38 of the Business Week Article.

"Arthur Andersen:  How Bad Will It Get?" Business Week, December 24, 2001, pp. 30-32 --- http://www.businessweek.com/ (not free to download for non-subscribers)

QUOTE 1
Berardino, a 51-year-old Andersen lifer, may find the firm's competence in auditing complex financial companies questioned.  While Andersen was its auditory, Enron's managers shoveled debt into partnerships with Enron's own ececs to get it off the balance sheet --- a dubious though legal ploy.  In one case, says Berardino, hoarse from defending the firm on Capitol Hill, Andersen's auditors made an "error in judgment" and should have consolidated the partnership in Enron's overall results.  Regarding another, he says Enron officials did not tell their auditor about a "separate agreement" they had with an outside investor, so the auditor mistakenly let Enron keep the partnership's results separate.  (Enron denies that the auditors were not so informed.)

QUOTE 2
Enron says a special board committee is investgating why management and the board did not learn about this arrangement until October.  Now that Enron has consolidated such set-ups into its financial statements, it had to restate its financial reports from 1997 onward, cutting earnings by nearly $500 million.  Damningly, the company says more than four years' worth of audits and statements approved by Andersen "should not be relied upon."

"Let Auditors Be Auditors," Editorial Page, Business Week, December 24, 2001, Page 96 --- http://www.businessweek.com/ (not free to download for non-subscribers)

But neither proposal (plans proposed by SEC Commission Chairman Harvey L. Pitt) goes far enough.  GAAP, the generally accepted accounting principles, desperately need to be revamped to deal with cash flow and other issues relevant in a fast-moving, high-tech economy.  The whole move to off-balance sheet accounting should be reassessed.  Opaque partnerships that hide assets and debt do not serve the interests of investors.  Under heavy shareholder pressure from the Enron fallout, El Paso Corp. just moved $2 billion in partnership debt onto the balance sheet. Finally, Pitt should consider requiring companies to change their auditors who go easy on them, as we have seen time and time again.

The Big Five Firms Join Hands (in Prayer?)
Facing up to a raft of negative publicity for the accounting profession in light of Big Five firm Andersen's association with failed energy giant Enron, members of all of the Big Five firms joined hands (in prayer?) on December 4, 2001 and vowed to uphold higher standards in the future. http://www.accountingweb.com/item/65518 

The American Institute of Certified Public Accountants released a statement by James G. Castellano, AICPA Chair, and Barry Melancon, AICPA President and CEO, in response to a letter published by the Big Five firms last week that insures the public they will "maintain the confidence of investors." --- http://www.smartpros.com/x32053.xml 

The SEC Responds
Remarks by Robert K. Herdman Chief Accountant U.S. Securities and Exchange Commission American Institute of Certified Public Accountants' Twenty-Ninth Annual National Conference on Current SEC Developments Washington, D.C., December 6, 2001 --- http://www.sec.gov/news/speech/spch526.htm 
Also see http://www.smartpros.com/x32080.xml 

Although the Securities and Exchange Commission has never in the past brought an enforcement action against an audit committee or a member of an audit committee, recent remarks by SEC commissioners and staff indicate this may change in the future. SEC Director of Enforcement Stephen Cutler said, "An audit committee or audit committee member can not insulate herself or himself from liability by burying his or her head in the sand. In every financial reporting matter we investigate, we will look at the audit committee." http://www.accountingweb.com/item/73263 

Message 1 (January 5, 2002) from a former Chairman of the Financial Accounting Standards Board (Denny Beresford)

Bob,

You might be interested in the following link to an article in the Atlanta newspaper that mentions my own economic setback re: Enron.

http://www.accessatlanta.com/ajc/epaper/editions/saturday/business_c3d246cc7171f08b0067.html 

Denny

In case it goes away on the Web, I will provide one quote from "INVESTMENT OUTLOOK: ENRON'S COLLAPSE: INVESTORS' COSTLY LESSON Situation shows danger of listening to analysts, failing to understand complex financial reports," Atlanta Journal-Constitution, December 29, 2001 --- http://www.accessatlanta.com/ajc/epaper/editions/saturday/business_c3d246cc7171f08b0067.html 

"When Warren Buffett spoke on campus a few months ago, he said you ought not to invest in something you don't understand," said Dennis Beresford, Ernst & Young executive professor of accounting at the University of Georgia.

That's one of the lessons for investors from the Enron case, according to Beresford and others. Another is that "some analysts are better touts than helpers these days,'' Beresford said.

"Enron was a very complicated company,'' he said. "Beyond that, its financial statements were extremely complicated. If you read the footnotes of the reports very carefully, you might have had some questions."

But a lot of individuals and institutional investors did not have questions, even months into the decline in Enron stock.

At least one brokerage house was recommending Enron as a "strong buy" in mid-October, after the stock had fallen 62 percent from its 52-week high last December. The National Association of Investors Corp., a nonprofit organization that advises investment clubs, featured Enron as an undervalued stock in the November issue of Better Investing magazine.

Beresford, a former chairman of the standards-setting Financial Accounting Standards Board, even bought "a few shares'' of Enron in October when the price dropped below book value. But he didn't hold them for long.

"It became clear to me that the numbers were going to be deteriorating very quickly and that the marketplace had lost confidence in the management,'' he said.

On Oct. 16, Enron announced a $1 billion after-tax charge, a third-quarter loss and a reduction in shareholder equity of $1.2 billion. A little more than a week later, Enron replaced its chief financial officer.

On Nov. 8, the company said it would restate its financial statements for the prior four years. On Dec. 2, Enron filed for Chapter 11 bankruptcy protection.

One of the issues in Enron's case is its accounting for hedging transactions involving limited partnerships set up by its then-chief financial officer. Enron's filings with the Securities and Exchange Commission reported the existence of the limited partnerships and the fact that a senior member of Enron's management was involved. But, as the SEC noted later, "very little information regarding the participants and terms of these limited partnerships were disclosed by the company."

"The SEC requires a certain amount of disclosure, but if you can't understand accounting, you're hobbled,'' said Scott Satterwhite, an Atlanta-based money manager for Artisan Partners. "If you can't understand what the accounting statements are telling you, you probably should look elsewhere. If you read something that would seem to be important and you can't understand it, it's a red flag.''

Message 2 (January 8, 2002) from Dennis Beresford, former Chairman of the Financial Accounting Standards Board

Bob,

In response to Enron, the major accounting firms have developed some new audit "tools" that can be accessed at: http://www.aicpa.org/news/relpty1.htm

Also, the firms have petitioned the SEC to require some new disclosures relating to special purpose entities and similar matters. The firms' petition is at: http://www.sec.gov/rules/petitions.shtml

I understand the SEC will probably also tell companies that they need to enhance their MD&A disclosures about special purpose entities.

Denny

From The Wall Street Journal's Accounting Educators' Reviews on January 10, 2002

TITLE: Accounting Firms Ask SEC for Post-Enron Guide 
REPORTER: Judith Burns and Michael Schroeder 
DATE: Jan 07, 2002 PAGE: A16 
LINK: http://interactive.wsj.com/archive/retrieve.cgi?id=SB1010358829367934440.djm  
TOPICS: Auditing, Accounting, Auditing Services, Auditor Independence, Disclosure, Disclosure Requirements, Regulation, Securities and Exchange Commission

SUMMARY: As a part of a greater effort to restore public confidence in accounting work, the Big Five accounting firms have asked the SEC to provide immediate guidance to public companies concerning some disclosures. In addition, the Big Five accounting firms have promised to abide by higher standards in the future.

QUESTIONS: 
1.) Why do the Big Five accounting firms need the SEC to issue guidance to public companies on disclosure issues? What is the role of the SEC in financial reporting? Why are the Big Five accounting firms looking to the SEC rather than the FASB?

2.) Why are the Big Five accounting firms concerned about public confidence in the accounting profession? Absent public confidence in accounting, what is the role, if any, of the independent financial statement audit?

3.) What role does consulting by auditing firms play in the public's loss of confidence in the accounting profession? Should an independent audit firm be permitted to perform consulting services for it's audit clients?

4.) What is the purpose of the management discussion and analysis section of corporate reporting? Is the independent auditor responsible for the information contained in management's discussion and analysis?

5.) Comment on the statement by Michael Young that, "Corporate executives are being dragged kicking and screaming into a world of improved disclosure." Why would executives oppose improved disclosure?

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

International Reactions and An Editorial from Double Entries on December 13, 2001

The big issue this week and one that is likely to dominate the accounting headlines for sometime is the Enron controversy. We have three items on Enron this week in the United States section including a brief summary from Frank D'Andrea and verbatim statements from the Big Five firms and the AICPA. We will continue to post the latest news to the website at http://accountingeducation.com  and as per normal a summary of those items in future issues of Double Entries.

While the Enron story is big, we also have extensive news from around the world including Australia, Canada, Ireland and the United Kingdom. It seems that the accrual accounting in government tidal wave that first started in New Zealand back in the early 1990s has now swept through Australia, the United States and now into Canada where the Canadian Federal government is to adopt accrual accounting. Who is to be next? Is this the solution to better financial accounting/accountability in the pubic sector? We welcome your views on this issue.

Till next week ...

Andrew Priest and Andy Lymer, Editors, 
AccountingEducation.com's Double Entries Double_Entries@accountingeducation.com 

[27] AICPA STATEMENT ON ENRON & AUDIT QUALITY The following is a statement from James G. Castellano, AICPA Chair and Barry Melancon, AICPA President and CEO on Enron and audit quality released on December 4, 2001. The statement has been reported verbatim for your information. Click through to http://accountingeducation.com/news/news2363.html  for the statement [AP].