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The Sad State of Professional Discipline in Public Accountancy
White Collar Crime Pays Even If You Get Caught
(It's
similar to arresting a Mafia boss in Italy)
"Despite convictions, Rigases live in the lap of luxury," by Jerry
Zremski, Buffalo News, December 3, 2006 ---
http://www.buffalonews.com/editorial/20061203/1074150.asp
Instead of facing immediate prison time,
experts say Rigases might win a new trial.
Nearly two and a half years after being
convicted of bank fraud and other corporate crimes, former Buffalo
Sabres owner John J. Rigas and his son Timothy remain comfortably at
home in Coudersport, Pa., awaiting the results of their appeal.
Meanwhile, many other executives who found
themselves on the government's rap sheet in recent years - Andrew Fastow
of Enron, Bernard Ebbers of WorldCom, Dennis Kozlowski of Tyco are all
behind bars.
What's more, lawyers close to the Rigas case
and independent experts are now entertaining a possibility that, to
trial-watchers, seemed laughable at the time of the Rigases' conviction
in July 2004: that they could win their appeal and thus face a retrial.
While it's rare for a federal appeals court to
reverse a criminal conviction, it's also rare for a court to take nearly
six months to decide such a matter. Yet that's how long ago a
three-judge appellate panel in New York City heard the Rigas appeal, and
some lawyers think the long wait for a decision is indication that the
court is taking the appeal very seriously.
"Usually, you expect a decision in a case like
this in about a month and a half," said Mark Mahoney, the Buffalo
attorney who won freedom for one of the Adelphia Communications Corp.
defendants, Michael Mulcahey. "The delay means they are taking more time
because the issues here are somewhat knotty."
Of course, the elaborate frauds concocted at
Enron, WorldCom and Tyco are inherently knotty, but courts were able to
unravel them sufficiently to make sure that the convicts in each case
went to prison comparatively quickly.
Ebbers was convicted in March 2005, lost an
appeal and was sent to a federal prison in Louisiana in September.
Fastow was sentenced in September and joined
Ebbers in Oakdale Federal Detention Facility this month.
And Kozlowski was sent to Mid-State
Correctional Facility in Marcy within weeks after his 2005 conviction
and even before he appealed.
There's one thing that separates all those
cases from the one that ensnared the Rigases, who ran Adelphia, a huge
cable company based in Coudersport. Their appeal raises a serious legal
question that even the judge in their trial agreed ought to be heard.
At a little-noticed court hearing in July 2005,
a month after he sentenced John Rigas to 15 years and Timothy Rigas to
20 years in prison, Judge Leonard B. Sand allowed them to go free on
bail pending their appeal.
He said he did so because the defense raised a
novel argument: the government persuaded the jury to convict the Rigases
of fraud and conspiracy based on their violations of generally accepted
accounting principles but never called an expert witness to explain what
those principles are.
At the hearing, Sand said he didn't necessarily
buy that argument, but added it "is something that I can't call
frivolous."
Mahoney said "a lot of people felt it was
generous" when Sand let the Rigases out on bail, because it's rare that
people convicted in the federal courts win that sort of freedom.
Denise O'Donnell, a former U.S. attorney in the
Western District of New York, agreed.
"There is a presumption against bail in the
federal system, so the Rigases had a very high hurdle to overcome just
to get released pending the appeal," she said.
The fact that they were released shows that
they "raised a substantive question of law" that could lead to the
reversal of their conviction, O'Donnell added.
Attorneys for the Rigases spelled out that
question at a hearing before a three-judge federal appeals panel on June
13.
Without an expert witness explaining accounting
rules, "the jury was never put in a position to decide whether the
Rigases' conduct was proper or improper," argued John Nields, the lawyer
for Timothy Rigas.
Richard Owens, the prosecutor in the case,
countered by saying the government didn't want to prolong an already
lengthy trial by starting "a battle of the experts."
Three federal judges are still pondering that
argument, and independent legal experts agreed with the Rigas attorneys
that the appeal needs to be taken seriously.
"I was surprised" that such an expert witness
wasn't called, said Eugene O'Connor, a former federal prosecutor who now
teaches law and accounting at Canisius College. "The question I have is:
How is the jury to assess with some certainty that these men violated
the accounting standards?"
Then again, the prosecution laid out a case
that, in the court of public opinion at least, might be seen as
difficult to refute.
Arguing that the Rigases treated Adelphia as
their "private piggy bank," Owens showed that John Rigas billed the
company for his Columbia House record club and used the corporate jet to
send Christmas trees to his daughter in New York City.
Timothy Rigas, meanwhile, dipped into corporate
funds to purchase 100 pairs of luxury slippers and a flight meant to
impress an actress friend.
In total, prosecutors said the Rigases "looted"
Adelphia of $100 million while hiding $2.3 billion in debt and
misleading banks and investors about Adelphia's earnings.
The jury convicted John and Timothy Rigas of 18
of the 23 charges against them. A mistrial was declared in the case of
another Rigas son, Michael, who later pleaded guilty and was sentenced
to home confinement.
That's not entirely different than what John
and Timothy Rigas are currently facing. Paul Shechtman, John Rigas'
appeals lawyer, said both John and Timothy Rigas are still in
Coudersport.
"Under the circumstances, John is doing as well
as can be expected," Shechtman said. "He's enjoying his grandchildren."
Of course, those circumstances could change at
any time. Lawyers close to the case said they don't know what to think
about the fact that the appeals court is taking so much time to render a
decision.
"It's usually a good sign," Shechtman said. "I
know they've issued opinions in cases that were heard after ours in
several instances."
However, the Second Circuit U.S. Court of
Appeals is especially busy and may simply want to take its time poring
over the record of the four-month trial, several lawyers said.
One thing is for sure: if the appeals court
rules for the Rigases and orders a retrial, it will be issuing an
opinion that will have ramifications far beyond the borough of 2,600
that the Rigases call home.
"It would be a huge decision with wide
ramifications in financial fraud cases," O'Donnell said. "I can't think
of any other similar case where this could happen."
You can read more about the Rigas' crimes and the Adelphia accounting
scandals at
http://www.trinity.edu/rjensen/Fraud001.htm#Ernst
"Director Capture,"
The Icahn Report, January 20, 2009 ---
http://www.icahnreport.com/
Jonathan Macey is Deputy Dean and Sam Harris Professor of
Corporate Law, Corporate Finance, and Securities Law at Yale Law School.
He is the author most recently of Corporate Governance: Promises Made,
Promises Broken (Princeton University Press, 2008) available at
http://www.amazon.com
The Icahn Report has exposed: (1) abuses in the
use of golden parachute agreements; (2) many of the false premises
behind the faulty assumption that corporate elections are "democratic"
event that legitimize corporate boards; (3) the entrenchment effects of
staggered boards of directors and, most importantly perhaps; (4) the
sheer corruption of law and morality that is represented by the
continued legality and adoption of poison pill defensive devices.
In my next two blog postings I would like to
bring my own, admittedly academic perspective to two topics that are, I
believe, highly relevant to the agenda of this blog. The first topic is
the problem of "board capture" among boards of directors of public
companies. The second is the general problem with shareholder democracy
caused by defects in the shareholder voting process.
Director Capture
In the academic world, particularly among
political scientists and economists, "capture" occurs when
decision-makers such as corporate directors favor certain vested
interests such as incumbent management, despite the fact that they
purport to be acting in the best interests of some other group, i.e. the
shareholders. The problem of capture and the theories associated with
the idea of capture are most closely associated with George Stigler, and
the free-market Chicago School of Economic thought. Among the more
interesting and important theories of Stigler and other proponents of
capture theory is the idea that capture is not only possible, in many
contexts it is inevitable.
In my recent Princeton University Press book
"Corporate Governance: Promises Made: Promises Broken" I apply capture
theory, which is usually used to describe and model the behavior of
bureaucrats in the public sector, to the directors of publicly traded
companies who come to their positions through the board nominating
committee.
In my view, such directors are highly
susceptible to capture… even more susceptible than bureaucrats and
politicians. Capture is inevitable because management controls the
machinery of the corporate election process. Management's narrow
interest in having passive and supportive boards manifests itself in the
appointment of docile directors who are likely to support management's
initiatives and unlikely to challenge management or to demand that
managers earn their compensation by maximizing value for shareholders.
The extension of capture theory to corporate
boards of directors is supported not only by foundational work in
political science and economics but also by important work in social
psychology. Directors participate in corporate decision-making. In doing
so, these directors, as a psychological matter, come to view themselves
in a very real way as the owners of the strategies and plans that the
corporation pursues. And of course, these plans and strategies
inevitably are proposed by incumbent management. Thus, directors
inevitably risk simply becoming part of the management "team" instead of
the vigorous outside monitors and evaluators that they are supposed to
be. Management’s persistent support of and acquiescence in the proposals
of management consistently renders directors incapable of objectively
evaluating these strategies and plans later on. Of course this is not
the case when the directors represent hedge funds or other large
investors who have a large financial stake in making sure that the
company prospers.
Another factor leading to board capture is the
fact that boards of directors have conflicting jobs. They are supposed
not only to monitor management, but also to select and evaluate the
performance of top management. After top managers have been selected,
the boards of directors making the selection decisions are highly likely
to become committed to these managers. For this reason, as board tenure
lengthens, it becomes increasingly less likely that boards will remain
independent.
The theory of "escalating commitments" predicts
that decision-makers such as corporate directors will come to identify
strongly with management once they have endorsed the strategies and
decisions made by management. Earlier board decisions supporting
management, once made and defended, will affect future board decisions
such that later decisions comport with earlier decisions. As the
well-respected Cornell psychologist Thomas Gilovich has shown, "beliefs
are like possessions" and "[w]hen someone challenges our beliefs, (for
example the belief of directors that management is highly competent) it
is as if someone [has] criticized our possessions."
The cognitive bias that threatens boards of
directors and other proximate monitors is a manifestation of what Daniel
Kahneman and Dan Lovallo have described as the "inside view." Like
parents unable to view their children objectively or in a detached
manner, directors tend to reject statistical reality (such as earnings
performance or stock prices) and view their firms as above average even
when they are not. The first step in dealing with the problem of board
capture is to recognize that the problem exists.
Boards should be free to choose whether they
wish to be trusted advisors of management or whether they want to be
credible monitors of management. They can’t be both. We should stop
pretending that they can.
One policy proposal would be for companies to
have two boards of directors (as they do in Germany and the
Netherlands), one for monitoring and one for assisting in the management
of the company. Firms that decide to retain the single board format
should be required to choose whether their board should devote itself to
"monitoring" (or supervising) management or to advising (or managing
along with) the company’s CEO and the rest of the management team. The
farce that board can do both should end.
Boards that purport to monitor or supervise
management should be held to an extremely high standard of independence.
Management should not be involved in any way in the recruitment or
retention of these board members. Socializing and gift-giving should be
prohibited. And, of course, managers themselves should not be allowed to
sit on monitoring boards. Managers should not be allowed to serve as the
chairmen of monitoring boards.
Independence standards should be relaxed for
the boards of companies that elect to participate in management.
Decisions that involve a conflict between the interests of shareholders
and the interests of management should be subjected to close scrutiny.
Such decisions include decisions about executive compensation of all
kinds, particularly bonus and severance payments, as well as decisions
about such things as the adoption of staggered terms for the board or
the adoption of a poison pill rights plan.
Continued in article
Bob Jensen's threads on corporate governance are at
http://www.trinity.edu/rjensen/Fraud001.htm#Governance
Bob Jensen's threads on great minds in management are at
http://www.trinity.edu/rjensen/theory/00overview/GreatMinds.htm
"SEC Accountant Fines Largely Go Unpaid," SmartPros, June 7, 2006 ---
http://accounting.smartpros.com/x53399.xml
The Securities and Exchange Commission has taken
disciplinary action against more than 50 accountants in 2005 and 2006 for
misconduct in scandals big and small. But few have paid a dime to compensate
shareholders for their varying levels of neglect or complicity.
It also turns out that nearly half of them continue
to hold valid state licenses to hang out their shingles as certified public
accountants, based on an examination of public records by The Associated
Press.
So while the SEC has forbidden these CPAs from
preparing, auditing or reviewing financial statements for a public company,
they remain free to perform those very same services for private companies
and other organizations that may be unaware of their professional misdeeds.
Some would say the accounting profession has taken
its fair share of lumps, particularly with the abrupt annihilation of Arthur
Andersen LLP and the jobs of thousands of auditors who had nothing to do
with the firm's Enron Corp. account. Meantime, the big auditing firms are
paying hundreds of millions of dollars in damages - without admitting or
denying wrongdoing - to settle assorted charges of professional malpractice.
Individual penance is another matter, however, and
here the accountants aren't being held so accountable.
Part of the trouble is that there doesn't appear to
be an established system of communication by which the SEC automatically
notifies state accounting regulators of federal disciplinary actions. In
several instances, state accounting boards were unaware a licensee had been
disciplined by the SEC until it was brought to their attention in the
reporting for this column. The SEC says it refers all disciplinary actions
to the relevant state boards, so the cause of any breakdowns in these
communications is unclear.
Another obstacle may be that some state boards do
not have ample resources to tackle the sudden swell of financial scandals.
It's not as if, for example, the Texas State Board of Public Accountancy had
ever before dealt with an accounting fraud as vast as that perpetrated at
Houston-based Enron.
"We don't have the staff on board to manage the
extra workload that the profession has been confronted with over the last
few years," said William Treacy, executive director of the Texas board. "So
we contracted with the attorney general's office to provide extra
prosecutorial power."
Treacy said his office is usually notified of SEC
actions concerning Texas-licensed CPAs, but the process isn't automatic.
With other states, communications from the SEC
appear less certain. If nothing else, many boards rely upon license renewals
to learn about SEC actions, but that only works if the applicants respond
truthfully to questions about whether they've been disciplined by any
federal or state agency. A spokeswoman for Georgia's board said one CPA
recently disciplined by the SEC had renewed his license online without
disclosing it.
Ransom Jones, CPA-Investigator for the Mississippi
State Board of Public Accountancy, said most of his leads come from other
accountants, media reports and annual registrations.
"The SEC doesn't necessarily notify the board,"
said Jones, whose agency revoked the licenses of key players in the scandal
at Mississippi-based WorldCom.
Some state boards appear more vigilant than others
in policing their membership. The boards in California and Ohio have
punished most of their licensees who have been disciplined by the SEC since
the start of 2005.
New York regulators haven't yet penalized any
locals targeted by the SEC in that timeframe, though they have taken action
against two disciplined by the SEC's new Public Company Accounting Oversight
Board. It is conceivable that cases are underway but not yet disclosed, or
that some individuals have been cleared despite the SEC's findings. A
spokesman for the New York State Education Department said all SEC referrals
are probed, but not all forms of misconduct are punishable under local
statute. New rules now under consideration would strengthen those
disciplinary powers, he said.
Meanwhile, although the SEC deserves credit for
de-penciling those CPAs who've breached their duties as gatekeepers of
financial integrity, barely any of those individuals have been asked to make
amends financially.
No doubt, except for those elevated to CEO or CFO,
most accountants are not paid as handsomely as the corporate elite. That
said, partners from top accounting firms are were [sic] paid well enough to
cough up more than the SEC has sought, which in most cases has been zero.
Earlier this year, in what the SEC crowed about as
a landmark settlement, three partners for KPMG LLP agreed to pay a combined
$400,000 in fines regarding a $1.2 billion fraud at Xerox Corp. One of those
fined still holds his license in New York.
"The SEC has never sought serious money from errant
CPAs," said David Nolte of Fulcrum Financial Inquiry LLP. "Unfortunately,
the small fines in the Xerox case set a record of the amount paid, so
everyone else has also gotten off easy."
It's not that the CPAs found culpable in scandals
don't deserve a right to redemption, or just to earn a living. Most of the
bans against practicing before the SEC are temporary, spanning anywhere from
a year to 10 years.
But the presumed deterrent of SEC action is
weakened if federal and state regulators don't work together on a consistent
message so bad actors don't get a free pass at the local level.
White collar crime punishments are a joke even if whistle blowing does
make them less funny
The main whistle-blower in the accounting fraud at HealthSouth Corp.
received the longest sentence so far in the case, while another former executive
received probation. U.S. District Judge Robert Propst sentenced former Chief
Financial Officer Weston Smith, 45 years old, to 27 months in prison, one year
of probation and ordered him to pay $1.5 million in forfeited assets. He pleaded
guilty in March 2003 to conspiracy, fraud and violating the Sarbanes-Oxley
corporate-reporting law. Assistant U.S. Attorney James Ingram, who asked the
judge for a five-year sentence, said Mr. Smith was the first person to reveal a
$2.7 billion fraud at the Birmingham, Ala., rehabilitation and medical-services
chain and would deserve an even longer sentence had he not come forward when he
did.
"HealthSouth Ex-Finance Chief Is Given 27-Month Prison Term," The Wall Street
Journal, September 23, 2005; Page C3 ---
http://online.wsj.com/article/0,,SB112741852577848939,00.html?mod=todays_us_money_and_investing
Bob Jensen's threads on
HealthSouth and Ernst &
Young are at
http://www.trinity.edu/rjensen/Fraud001.htm#Ernst
White Collar Crime Pays
Even if You Get Caught
For example Andy Fastow
stole over $60 million from
Enron and was required to
pay back less than $30
million. Where will
the remainder be when he
emerges a free man in a few
years?
It gets harder to get convictions for white collar crime
In Oregon this month, a judge dismissed criminal
charges against three corporate executives, saying the Justice Department
unconstitutionally pursued a stealth criminal investigation under the cloak
of a less-threatening civil proceeding by the SEC. And in Alabama last year,
a judge dismissed charges that former HealthSouth Corp. Chief Executive
Richard Scrushy lied to the SEC, ruling that he should have been warned that
the Justice Department already had opened a criminal investigation when the
SEC questioned him. In both cases, the judges found the line between the
agencies' roles had become improperly blurred.
Peter Lattman and Kara Scannell, "Slapping Down a Dynamic Duo: SEC and the
Justice Department Fight Financial Crime Together, But Is It an Unfair
Double-Team?" The Wall Street Journal, January 25, 2006; Page C1---
http://online.wsj.com/article/SB113815854524255591.html?mod=todays_us_money_and_investing
Executive Compensation: Here's how it works even in bankruptcy
Last Wednesday, the judge overseeing the UAL
Corporation's reorganization approved an executive pay package that would
give rich salaries and at least $115 million worth of stock to the airline
company's chief executive, Glenn F. Tilton, and other senior managers, when
UAL emerges from Chapter 11. UAL said the executive pay was necessary to
attract and retain experienced managers. But the judge's approval surprised
Brian Foley, an executive pay expert in White Plains. For starters, he
noted, the plan was created by Towers Perrin for the UAL board. Towers
Perrin also happens to have done work for UAL management.
"A Little Too Close for Comfort at UAL?" The New York Times, January
22, 2006 ---
http://www.nytimes.com/2006/01/22/business/yourmoney/22suits.html
Jensen Comment
All the pilots, flight attendants, machinists, ticket agents, baggage
handlers, and other UAL employees took pay cuts. Why not the top
brass? Just goes to show you that there's no economic law of supply and
demand at the CEO level. It's all a matter of back scratching where the CEO
appoints the Board that in turn decide how much the CEO can loot from
shareholders.
I don't know whether to post this to my "White Collar Crime" module or my
"Outrageous Executive Compensation" module. These days both modules should
probably be merged.
White Collar Crime
Pays
This is how rich guys loot
companies
Many Private-Equity Firms
Drain Out Dividends and
Fees, Saddling Companies
With Debt
"Takeover Artists Quench
Thirst," by Henny Sender,
The Wall Street Journal,
January 5, 2006; Page C1---
http://online.wsj.com/article/SB113643186947238360.html?mod=todays_us_money_and_investing
The ink had barely dried on the sale documents
about a year ago when the new private-equity owners of satellite operator
Intelsat -- Apax Partners Inc., Apollo Management, Madison Dearborn Partners
and Permira Advisers -- paid themselves a $350 million dividend financed
with newly issued Intelsat debt.
In a technique practically unheard of just five
years ago, private-equity firms, emboldened by easy financing, are paying
themselves lavish dividends and fees from the companies they acquire.
Typically, private-equity firms have generated returns by acquiring
companies with a mix of cash and debt, taking them private, restructuring
them and then either taking them public or selling them.
But a favorable financing environment has given
rise to a high volume of dividends and fees, often paid well ahead of any
operational turnaround, primarily through the aggressive issuance of debt by
the acquired companies. A spokesman for Apollo, which led the Intelsat
transaction, declined to comment.
In the past two years, private-equity firms
garnered more than $50 billion from so-called dividend recapitalizations,
according to Standard & Poor's Corp. By contrast, there were virtually no
such dividend financings just five years ago. As much as 50% of the returns
that buyout firms have paid their investors in the past two years came from
such dividends, financed mostly with new debt, according to calculations by
some private-equity firms.
The pace of the dividends is dizzying. Blackstone
Group bought Celanese Corp. for $3.4 billion in June 2004, contributing $650
million of the purchase price. In the nine months following the closing,
Celanese paid Blackstone $1.3 billion in dividends.
Continued in article
It pays to be an
accounting cheat because you
don't have to return your
bonus that you got by
cheating
Hundreds
of companies have restated
earnings in recent years -
414 in 2004 alone, according
to a recent study by the Huron
Consulting Group. And in
many cases, the revisions
came in the wake of
discoveries of questionable
accounting or other possible
wrongdoing that meant the
numbers leading to bonuses
were inaccurate. But a
review of restatements by
large corporations shows
that companies very, very
rarely - as in almost never
- get that money back. The
list of restatements was
compiled for Sunday Business
by Glass Lewis &
Company, a research firm
based in San Francisco.
Jonathan D. Glater,
"Sorry, I'm Keeping the
Bonus Anyway," The
New York Times, March
13, 2005 --- http://www.nytimes.com/2005/03/13/business/yourmoney/13restate.html?
White collar crime still is punished lightly
"Ex-Finance Chief At HealthSouth Gets 5 Years in Jail," by Chad Terhune, The
Wall Street Journal, December 10, 2005; Page A3 ---
http://online.wsj.com/article/SB113415352157818617.html?mod=todays_us_page_one
A federal judge in
Birmingham, Ala., sentenced former HealthSouth Corp. finance
chief William T. Owens, the star witness against company founder
Richard Scrushy at his criminal trial, to five years in prison.
U.S. District Judge Sharon Blackburn
expressed reservations at sending Mr. Owens, 47 years old, to
prison, saying she believed Mr. Scrushy directed the $2.7
billion accounting fraud at the health-care company. Mr.
Scrushy's trial ended in acquittal in June.
Friday, the judge called it a
"travesty" that Mr. Scrushy wouldn't spend any time in prison in
connection with the scheme. Mr. Scrushy and his lawyers have
repeatedly denied participating in the fraud, claiming that Mr.
Owens was the mastermind of the plan and hid it from Mr. Scrushy.
In a statement, Mr. Scrushy said Judge Blackburn's comments were
"totally inappropriate given that there was not one shred of
evidence or credible testimony linking me to the fraud."
Frederick Helmsing, the lawyer for Mr.
Owens, had sought probation, in light of Mr. Owens's extensive
cooperation with the government investigation since 2003.
Prosecutors requested an eight-year prison term.
Continued in article
HealthSouth's auditing firm was Ernst & Young ---
http://www.trinity.edu/rjensen/Fraud001.htm#Ernst
This is absolutely
unfair! If a CEO loots
his/her company, the company
pays insurance for all legal
costs of the CEO even if
he's convicted of looting
the company that pays the
insurance premiums.
A
company that insured Tyco
International Ltd.
executives must pay legal
bills for former Chief
Executive L. Dennis
Kozlowski, who is on trial
on corporate-looting
charges, an appeals court
said. In a 5-0 ruling, the
New York Supreme Court
Appellate Division left open
the possibility that Federal
Insurance Co., a Chubb Corp.
subsidiary, could later
recover some of the costs
from Mr. Kozlowski. A lower
court judge had ruled that
Federal Insurance, which
provided liability coverage
to Tyco, was required to pay
Mr. Kozlowski's legal bills
. . . Mr. Kozlowski and Mark
H. Swartz, Tyco's former
chief financial officer, are
accused of stealing $170
million from the
conglomerate by hiding
unauthorized pay and bonuses
and by abusing loan
programs. They also are
accused of making $430
million by inflating the
value of Tyco stock by lying
about the company's
finances. Their retrial in
Manhattan's State Supreme
Court on charges of grand
larceny, falsifying business
records and violating state
business laws is ending its
second month. Their first
trial ended in a mistrial in
April.
Associated Press,
"Insurer to Pay Kozlowski's
Costs," The Wall Street
Journal, March 24, 2005;
Page C3 --http://online.wsj.com/article/0,,SB111161345997387951,00.html?mod=todays_us_money_and_investing
Justice Lite: Scott Sullivan
gets five years with the possibility of
earlier parole
WorldCom Inc.'s
former chief financial officer, Scott
Sullivan, who engineered the $11 billion
fraud at the onetime telecom titan, was
sentenced to five years in prison -- a
reduced term that sent a signal to
white-collar criminals that it can pay to
cooperate with the government. Mr.
Sullivan's reduced sentence came after
prosecutors credited his testimony as
crucial to the conviction of his former boss
and mentor, Bernard J. Ebbers, who founded
the company, which is now known as MCI Inc.
Last month, Mr. Ebbers was sentenced to 25
years in prison.
Shawn Youg, Dionne Searcey, and Nathan Kopp,
"Cooperation Pays: Sullivan Gets Five
Years," The Wall Street Journal,
August 12, 2005, Page C1 ---
http://online.wsj.com/article/0,,SB112376796515410853,00.html?mod=todays_us_money_and_investing
A WSJ video is available at
http://snipurl.com/SullivanVideo
Bob Jensen's threads on the Worldcom
accounting scandal are at
http://www.trinity.edu/rjensen/FraudEnron.htm#WorldCom
Justice Lite:
Rite Aid Ex-CEO's Sentence
Pared
A federal judge on
Thursday trimmed a year from
the eight-year sentence of
former Rite Aid Corp. Chief
Executive Martin L. Grass
for conspiring to obstruct
justice and to defraud the
nation's third-largest
drugstore chain and its
shareholders. U.S. District
Judge Sylvia H. Rambo said
she acted to reduce a
disparity between Mr. Grass
and other defendants
sentenced for similar
crimes. Mr. Grass, 51 years
old, smiled and blew a kiss
to family members as federal
marshals led him from the
courtroom.
"Rite Aid Ex-CEO's Sentence
Pared," The Wall Street
Journal, August 12,
2005; Page C3 ---
http://online.wsj.com/article/0,,SB112379123643311147,00.html?mod=todays_us_money_and_investing
Of
all the lawsuits, one filed
against Mr. Winnick last
October in federal court in
Manhattan holds special
significance. J. P. Morgan
Chase and other leading
banks are seeking $1.7
billion in damages from Mr.
Winnick and other Global
Crossing executives,
contending that the group
engaged in a "massive
scam" to
"artificially
inflate" the company's
performance to secure
desperately needed loans.
Mr. Winnick, whose lawyers
dispute the accusations,
declined to be interviewed
for this article.
Among other things, the suit
refocuses attention on
exactly what Mr. Winnick
knew about his company's
finances during times when
it was borrowing heavily and
he was selling hundreds of
millions of dollars in
stock. It also outlines a
troubling series of meetings
he held with Mr. Lay and
other Enron executives just
months before their company
crumpled.
Timothy O'Brian, "A New
Legal Chapter for a 90's
Flameout," The New
York Times, August 15,
2004 --- http://www.nytimes.com/2004/08/15/business/yourmoney/15win.html
Makes You Sick to Your Stomach
How Crooked Corporate Executives Get Away With Their Heists
As
Conseco struggles to reclaim
hundreds of millions of
dollars in delinquent loans,
it is discovering just how
adept former executives can
be at hanging on to their
money. And, like other
companies in its place, the
insurer is getting
increasingly aggressive in
dunning its former
executives.
"Playing Hide &
Seek With Cash: More
Firms, Like Conseco, Find
It's No Game Trying to
Reclaim Bad Loans to Former
Executives," by Joseph
T. Hallinan, The Wall
Street Journal,
February 9, 2005; Page C1---
http://online.wsj.com/article/0,,SB110790426901949318,00.html?mod=todays_us_money_and_investing
Some
islands off New Zealand?
Your spouse? A house in
Florida? Where would you
stash gobs of money that
somebody was trying to
grab?
As
Conseco Inc. struggles to
reclaim hundreds of
millions of dollars in
delinquent loans, it is
discovering just how adept
former executives can be
at hanging on to their
money. And, like other
companies in its place,
the insurer is getting
increasingly aggressive in
dunning its former
executives.
For
instance, the former
WorldCom Inc. (now MCI
Inc.) is zealously
pursuing $400 million it
says it is owed by former
Chief Executive Bernard J.
Ebbers, who faces a fraud
trial in U.S. federal
court in New York City.
"The climate has
changed totally,"
says Pearl Meyer of Pearl
Meyer & Partners, an
executive-compensation
consultant to boards,
compensation committees
and management.
In
the past, she says,
"companies would not
even endeavor to recapture
compensation." Now,
though, companies
routinely include "clawback
provisions" in their
executive employment
agreements, entitling the
companies to take back
compensation under certain
circumstances.
"Clawback"
is an apt term for what
Conseco is attempting.
During the 1990s, the
Carmel, Ind., company
arranged for its top
executives and directors
to borrow hundreds of
millions of dollars for
use in buying the
company's then-soaring
stock. In some cases,
Conseco lent money
directly to the
executives; in most cases,
it guaranteed their loans
from banks.
Such
loans are no longer
permitted under the
Sarbanes-Oxley
securities-reform act of
2002, says Charles M.
Elson, director of the
Weinberg Center for
Corporate Governance at
the University of
Delaware. But while they
were legal, Conseco made
the most of them. Its loan
program for directors and
officers swelled to more
than $600 million as
officials snapped up 19
million company shares.
Soon after, Conseco's
fortunes crashed. Under
the weight of a sagging
mobile-home loan business,
it was forced in 2000 to
restate results. Its stock
price plunged, and in 2002
Conseco filed for
bankruptcy-court
protection.
It
emerged from bankruptcy in
2003 and ever since has
been trying to collect on
those loans. The chief
target these days is
former Conseco Chairman
and CEO Stephen C.
Hilbert. In an interview,
Mr. Hilbert accuses
Conseco's law firm,
Chicago-based Kirkland
& Ellis, of having
used "every
below-the-belt legal
tactic known to mankind.
It's been pathetic."
Reed
S. Oslan, a partner with
the firm, responds that
Mr. Hilbert "has no
one but himself to blame
for the litigation Conseco
was compelled to
bring," adding that
"a high degree of
resolve on the part of the
lender" is expected,
given how much money is at
stake.
Conseco
contends Mr. Hilbert owes
it $248.2 million. During
his heyday, the college
dropout and former
encyclopedia salesman was
among the country's most
highly paid executives,
pulling in over $100
million a year at peak
compensation.
Today,
Mr. Hilbert, 59 years old,
pleads poverty. At a
hearing in November in
Hamilton County Circuit
Court in Indiana, he said
he had virtually no income
and only $175 cash in his
pocket, and that his wife,
Tomisue Hilbert, 34,
"generously"
pays his bills.
Since
he was ousted from Conseco
in 2000, Mr. Hilbert has
transferred some $100
million in assets to his
wife, according to court
filings by Conseco. The
sum includes $20 million
in cash and an interest in
a Caribbean chateau.
Phillip
Fowler, an attorney
representing Mr. Hilbert,
says any transfers Mr.
Hilbert made to his wife
were "completely
proper" and that
Conseco isn't entitled to
recover anything from Mrs.
Hilbert. "Tomisue
Hilbert owes not a dime to
Conseco -- period,"
Mr. Fowler says.
Continued in the
article
"25 Reasons Employees
Lie, Cheat, and Steal,"
SmartPros,
September 2006 ---
http://accounting.smartpros.com/x54052.xml
On-the-job theft goes beyond greed, according
to authorities in white-collar crime (criminologists, sociologists,
auditors, risk managers, etc.), who cite a large list of reasons for
employee theft.
In fact, a new edition of Fraud Auditing and
Forensic Accounting lists a long list of 25 reasons -- some of which
are common knowledge, but others may surprise. They include:
- The employee believes he can get away with
it.
- No one has ever been prosecuted for
stealing from the organization.
- Employees are not encouraged to discuss
personal or financial problems at work or to seek management's
advice and counsel on such matters.
Read the entire list and check out Book Corner
for more details on the book.
A
Politically Divided SEC:
Why We Can't Trust
Government Agencies to
Protect US from Big Business
"SEC Won't Charge,
Fine Global Crossing
Chairman: Agency's
Donaldson Goes Against
Staff, Noting Winnick's
Nonexecutive Role," by
Deborah Solomon, The Wall
Street Journal, December
13, 2004; Page A1 --- http://online.wsj.com/article/0,,SB110290635013498159,00.html?mod=todays_us_page_one
The
Securities and Exchange
Commission won't file
civil securities charges
against former Global
Crossing Ltd. Chairman
Gary Winnick over
disclosure violations or
impose a $1 million fine,
according to people
familiar with the matter.
The
action came despite
objections from the SEC's
two Democratic members and
represents a rare reversal
by the commission of its
enforcement staff. It also
caps a lengthy
investigation of Global
Crossing, the former Wall
Street darling that helped
set off a gold rush to
capitalize on the Internet
boom of the late-1990s.
.
. .
The
SEC had been expected to
fine Mr. Winnick $1
million for failing to
properly disclose a series
of transactions undertaken
by the telecom company,
and he had tentatively
agreed to pay that sum as
part of a settlement
agreement. But at a
closed-door commission
meeting last week, SEC
Chairman William Donaldson
and his two
fellow Republican
commissioners,
Cynthia Glassman and Paul
Atkins, opposed a staff
recommendation to charge
Mr. Winnick. Mr. Donaldson
expressed concern that Mr.
Winnick was a nonexecutive
chairman and hadn't signed
off on the inadequate
disclosure, these people
said.
This
is what happens when
Republicans win elections
(and I'm a Republican)
The
SEC is facing resistance
from
two Republican commissioners
over
the stiff fines it has been
imposing on companies.
Deborah Solomon, "As
Corporate Fines Grow, SEC
Debates How Much Good They
Do," The Wall Street
Journal, November 12,
2004 --- http://online.wsj.com/article/0,,SB110021198122471832,00.html?mod=home_whats_news_us
Bob Jensen's threads on why
white collar crime pays
(even when you get caught)
are at http://www.trinity.edu/rjensen/FraudConclusion.htm#CrimePays
It's
about time.
The
SEC staff is set to propose
an overhaul of rules
governing how billions of
shares trade each day in the
U.S. The proposed plan would
expand a trading rule to
mandate that investors are
entitled to the best price
for most stock orders on
both the NYSE and Nasdaq.
Kate Kelly and
Deborah Solomon, "SEC
Preps 'Best-Price' Overhaulm"
The Wall Street Journal,
November 22, 2004 --- http://online.wsj.com/article/0,,SB110108697957180493,00.html?mod=home_whats_news_us
Forget
it! The DC part of
Washington DC means Donate
Cash
"SEC Loves NYSE," The
Wall Street Journal,
December 6, 2004; Page A14
Never
underestimate the ability
of a bureaucracy to wiggle
backward. After many
months of heavy breathing,
the Securities and
Exchange Commission is
about to take stock
trading back several
decades. If you're
thinking: Hmmm, this will
help the New York Stock
Exchange, you're right.
Back
in February, the SEC
proposed an overhaul of
the national market
system, called Reg NMS.
The idea was to modernize
an increasingly laborious
and inefficient structure
put in place in the 1970s.
The main driver for
reform, especially from
institutional investors
who often trade on behalf
of smaller investors, was
the trade-through rule.
This
little bit of regulatory
favoritism dictates that
traders must do business
with the exchange showing
the "best" price
for a security. It has
also long given the New
York Stock Exchange, with
its auction system of
stock specialists on the
trading floor, a monopoly
on a large amount of
trading. Of course, having
a monopoly, the NYSE had
little incentive to
upgrade its trading
technology. And it didn't
for years. Meanwhile, all
sorts of swift, efficient
electronic markets were
created.
Institutional
investors now find that
they can trade faster,
with anonymity and
confidence, on these
electronic markets. But
the trade-through rule
hinders them. The NYSE
argues that this rule
protects small investors
who otherwise might not
get the "best"
price. In fact, the
"best" price on
the NYSE is often just a
"maybe" price
because it can disappear
during the 15-30 seconds
it takes to execute an
order. On electronic
venues, however, the price
is firm and execution is
achieved as soon as the
computer key is hit.
The
SEC's February proposal
stopped short of
abolishing the
trade-through rule, but it
did relax it. The proposal
would have allowed traders
to ignore the best price
within a certain range and
granted an explicit
opt-out -- investors could
give permission to ignore
the best price on an
order-by-order basis.
Essentially, the proposal
recognized the virtues of
fast, automated markets by
giving them trading
priority over slow, manual
markets.
The
NYSE -- the queen of slow
markets -- went wild. It
aggressively lobbied
against the SEC proposal
and, in an effort to
qualify as a fast market,
introduced the first real
reform in decades. In a
plan unveiled in August,
the NYSE has proposed to
make itself into a
"hybrid" market
by expanding its tiny
automated system, called
Direct Plus.
The
new Direct Plus lifts
restrictions on size and
timing of orders, allows
orders that are not
immediately executed to be
canceled, and permits
investors to gobble up or
dump a lot of shares in
one sweep at multiple
prices. Specialists will,
however, retain their
role. The plan allows for
the automatic market to
switch into an auction
mode if additional
"liquidity"
becomes necessary -- which
sounds as if the NYSE is
up to its old tricks. At
least the threat of losing
its monopoly has, finally,
spurred the Big Board into
some long-needed changes
toward automated trading.
But
then came word that the
SEC has backpedaled. In a
draft scheduled to be
voted on this month, the
new Reg NMS has dropped
the opt-out provision and
extended the trade-through
rule to Nasdaq. Rumors
were that all markets will
also be required to
display their full
depth-of-book -- the
entire list of bids and
offers -- not just their
best price. Simply put,
the trade-through rule
would not only be retained
but would reign supreme.
The uproar over this news
has been so loud that the
SEC has now agreed to put
the new rule out for
comment before any final
vote.
Extending
trade-through to Nasdaq is
an unnecessary extension
of regulatory reach. The
SEC itself has admitted
that, even without a
trade-through rule, Nasdaq
offers competitive quoting
in actively traded stocks.
Moreover, recent academic
studies show that there is
less volatility on Nasdaq
and other electronic
trading markets.
The
impetus for reforming the
national market system was
an acknowledgement that
both the technology and
motives for trading have
changed radically in the
past 30 years. The
practical point was to
break the monopoly
strictures so that
competition among markets
would direct order flow to
the venues that best
suited investors. There is
an argument that the NYSE,
with its specialists,
provides value for trading
medium- and low-cap
stocks, and no doubt the
Big Board will retain its
market share if that's the
case. But that hardly
suggests that trading in
the most liquid stocks
should be forced into the
NYSE.
And
so after all this, the SEC
has failed to grapple with
the central question: Why
shouldn't the markets for
trading stocks be free to
compete on service and
innovation? Instead, it
looks like the SEC is
going to give investors
the same-old, very old,
story.
Bob Jensen's threads on
proposed reforms are at http://www.trinity.edu/rjensen/FraudProposedReforms.htm
Securities
regulators are probing
whether fund companies
directed trades toward firms
that lavished them with
"excessive" gifts.
SEC, NASD Investigate
Whether Securities Firms
Gave Excessive Presents
Deborah Solomon, "Probe
Focuses on Gifts to
Advisers," The Wall
Street Journal, November
25, 2004, Page c19 --- http://online.wsj.com/article/0,,SB110123997986182154,00.html?mod=home_whats_news_us
Bob Jensen's thread on
securities trading frauds
are at http://www.trinity.edu/rjensen/fraudRotten.htm
So
where was Levitt before
Spitzer did his job?
While heading up the SEC,
Levitt always seemed willing
to take on the CPA firms,
but he treaded lightly
(really did very little)
while the financial industry
on Wall Street ripped off
investors bigtime. It
never ceases to amaze me how
Levitt capitalizes on his
failures.
Forget
Enron, WorldCom or mutual
funds. The crisis enveloping
the insurance industry is
"the scandal of the
decade, without a
question" and
"dwarfs anything we've
seen thus far."
Arthur Levitt as quoted by SmartPros,
October 25, 2004 --- http://www.smartpros.com/x45590.xml
Bob Jensen's threads on
insurance frauds are at http://www.trinity.edu/rjensen/fraudRotten.htm#MutualFunds
In my view Global Crossings is the pinnacle of
corporate management profiteering. I cannot believe that Justice did not
prosecute this obvious case of fictitious earnings manipulation and Gary
Winnick is left with over $735 million when investors had an 18 billion
collapse.
Miklos A. Vasarhelyi, Rutgers University, August 15, 2004 email message
In all, four months in a
minimum-security prison seemed like a small price to pay for the millions
of dollars Mozer made. In 2001, Mozer was enjoying his wealth--relaxing,
and raising his eight-year-old daughter. He spent much of his time
managing his own money and playing golf. Mozer's treatment raised an
interesting question: what would most
people have done in his situation--assuming they knew in advance they
would be caught and spend four months in a low-security prison--if they
also knew that, afterward, they would retire as a multimillionaire, all
before their fortieth birthday? Compared
to Mozer, his supervisors received mere slaps on the wrist. Gutfreund,
Strauss, and Meriweather paid fines of $100,000, $75,000, and $50,000,
respectively--just a few days' pay, at their salaries.
Frank Partnoy, Infectious Greed (Henry Holt and Company, 2004, Page
109) with respect to derivatives fraud at Salomon.
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 threads on corporate fraud are at
http://www.trinity.edu/rjensen/fraud.htm
Bob Jensen's updates on fraud are at
http://www.trinity.edu/rjensen/fraudUpdates.htm
"Hard Time? Hardly In 1999 we wrote about some accounting bad guys who
seemed to have airtight cases against them. Guess how many went to jail?"
by Carol J. Loomis, Fortune magazine, March 18, 2002, Page 78 --- http://www.fortune.com/indexw.jhtml?channel=artcol.jhtml&doc_id=206662
Raise your hand if you think one or more Enron
executives should go to jail. The yes votes on that one would surely put
President Bush's approval rating to shame. We might even get past 99.99%
affirmative, with only the Lay, Skilling, and Fastow families voting no.
But the fact is that putting bigtime executives in
jail for perpetrating accounting frauds has proved very hard to do. Some 2 1/2
years ago (Aug. 2, 1999) FORTUNE ran an article, Lies, Damned Lies, and
Managed Earnings, that spotlighted the accounting scandals of the time. Of the
big ones then generating tales of absolutely egregious behavior, none has
produced jail sentences.
Indeed, only one produced a sentence of any kind:
Bruce J. Kingdon, who had run a division of Bankers Trust that did securities
processing, pleaded guilty in September 2000 to conspiracy and falsifying bank
records, and was ordered to perform 450 hours of community service, see a
therapist once a week for three years, and pay fines of $180,500. (Bankers
Trust itself had earlier paid a $63 million fine.) Kingdon's lawyer says his
client's community service consisted of work for a medical
cause--"cerebral palsy or muscular dystrophy or something like
that."
Jail sentences could yet come out of several other
cases, including two that have actually produced indictments. The zinger is
likely to be the case against two prominent CUC International executives, CEO
Walter Forbes and President Kirk Shelton, who in 1997 merged their company
with HFS Inc. to form Cendant. A scant four months later CUC's accounting was
exposed as rotten, and Cendant's market value dropped $14 billion in one day.
In time the U.S. Attorney for New Jersey, working
with the SEC, wrung cooperating plea agreements from three former CUC
financial executives, who are expected to testify against Forbes and Shelton.
The two men are charged with three types of fraud--securities, mail, and
wire--and with conspiracy to lie to the SEC. In their trial, scheduled to
start in Newark in September, they will face a morally outraged team of
prosecutors, one of whom says, "This is war." Forbes and Shelton
cannot have been helped by the furor over Enron.
The second batch of indictments emerged from another
merger-related mess, arising from McKesson's acquisition of software supplier
HBO & Co. in January 1999. Again, within months rot was exposed, this time
in HBO's accounting. (Say, whatever happened to the due diligence that
supposedly precedes mergers?) After a criminal investigation headed by San
Francisco Assistant U.S. Attorney Leslie Caldwell, the two co-presidents of
HBO, Albert Bergonzi and Jay Gilbertson, were charged with the fraud
battery--securities, mail, and wire--and with conspiracy. No date has been set
for their trial, and Caldwell won't, in any case, be apt to take part in it.
She's now heading the Department of Justice task force that's investigating
Enron.
"Massive financial fraud" is what the SEC
says occurred at both McKesson and Cendant. But that is also how it described
the goings-on a few years ago at Sunbeam and Waste Management, and those cases
have brought no criminal indictments. That means the executive everyone loves
to hate, deposed Sunbeam CEO Al Dunlap, has escaped charges, and so has Waste
Management's former CEO, Dean Buntrock. Other escapees: partners of Arthur
Andersen & Co., which was the outside auditor at both Sunbeam and Waste
Management (and, as all the world knows, at Enron).
The weirdest
accounting case around is one in which
indictments have existed for years, but nothing has made it to court. Here, in
early 1999, the U.S. Attorney for the Southern District of New York, Mary Jo
White, charged Garth Drabinsky and Myron Gottlieb of theatrical producer
Livent with 15 counts of fraud and one of conspiracy. But Drabinsky and
Gottlieb had already fled to Canada, Drabinsky's homeland--and there they
remain today. No wonder, since the U.S. Attorney's office has never moved to
extradite them, even though it vowed from the start to do so.
Continued at http://www.fortune.com/indexw.jhtml?channel=artcol.jhtml&doc_id=206662
"No Wonder C.E.O.'s Love Those Mergers," by Gretchen
Morgenson, The New York Times, July 18, 2004 --- http://www.nytimes.com/2004/07/18/business/yourmoney/18watch.html
Shareholders like it when their companies are
acquired, because their stocks rise in value. Chief executives like it,
too, because their severance agreements kick in. And that means they can
become truly, titanically, stupefyingly rich.
Wallace R. Barr, the chief executive of Caesars
Entertainment, is the latest to line up for his barrel of bucks. Last
week, Harrah's announced it would acquire Caesars for $5.2 billion.
Thanks to accelerated vesting of options and stock awards, Mr. Barr
stands to receive almost $20 million under so-called change-of-control
provisions in his contract. And if Mr. Barr resigns from Caesars
"for good reason," the contract says, he is entitled to an
additional $6.6 million after the two companies merge.
A spokesman for Caesars did not return a phone
call seeking comment.
Then there was Wachovia's proposed acquisition
of the SouthTrust Corporation last month. Equilar Inc., a compensation
analysis firm in San Mateo, Calif., said the terms of the deal would
give Wallace D. Malone Jr., the chief executive of SouthTrust. $59
million in termination awards, stock awards and options over the next
five years if he leaves the bank. He also appears to be entitled to an
annual pension of about $3.8 million.
At least Mr. Malone has said he would donate
some of this bounty to charity. A spokeswoman for SouthTrust did not
return a phone call seeking comment.
"In theory, change-in-control provisions
make sense," said Tim Ranzetta, the president of Equilar.
"They encourage executives to act in the best interests of
shareholders in transactions that they anticipate will increase
shareholder value, which at the same time may harm their own careers.
But empirical research seems to indicate that most companies
underperform relative to the market after a merger while executives
benefit from these large, one-time payouts."
Amazingly few shareholders have carped about
these giveaways. The California Public Employees' Retirement System, the
big pension fund known as Calpers, voted against last month's merger of
two health care companies, Anthem Inc. and WellPoint Health Networks,
citing excessive pay. Executives stood to receive bonuses, severance
payments and vested stock options totaling approximately $200 million in
the deal. Leonard D. Schaeffer, WellPoint's chief executive, was
entitled to $47 million in severance, stock options and enhanced
retirement benefits, an Anthem spokesman said.
Nobody else seemed to mind. Shareholders
approved the merger on June 28.
One reason that shareholder outrage has been
muted may be that few people, beyond the executives themselves and maybe
the company's compensation committee, know how costly these pay deals
are. Even with all the scrutiny of corporate governance in recent years,
a full tally of what executives will earn in retirement or under a
change of control is simply not disclosed. Not anywhere.
Experts say that many compensation committees
do not understand the size of these pay packages because they do not
routinely ask their consultants for detailed lists of the various pay
components.
And, my, how the list of goodies can go on.
First comes the executives' severance pay, almost always nearly three
times salary and bonus. Accelerated vesting of stock options and stock
awards quickly follows; sometimes the options are granted with their
full terms remaining - up to 10 years - giving them tremendous value.
Then there are the three additional years of
pension credits that get tacked on to an executive's pay, as well as the
401(k) match, years of health care benefits and the cash value of
perquisites at the time of termination - such as use of the corporate
jet, country-club memberships, allowances for financial planning advice,
office space and secretarial services. All in one delightfully fat lump
sum.
AND don't forget that executives' pensions are
often based on the unusually high severance pay, which ratchets the
numbers way up.
Of course, one downside to these enormous
payments is that they generate stunning tax bills for executives. Good
thing their contracts almost always require the companies to pay. And
how!
The so-called excise tax gross-up provisions
can be so colossal that, according to one pay expert, a major merger was
scuttled because the cost to cover executives' tax bills exceeded $100
million.
I view these executive compensation schemes as white collar crime,
and white collar crime just does not get punished severely enough to stop
the epidemic.
White collar crime pays even in the
unlikely event that perpetrators get caught. With millions of ill-gotten gains
stashed away off shore or in the hands of friends and relatives, a white collar criminal
looks forward to retirement in luxury after serving a few months or years in a Federal
country club deceivingly called a prison.
Related
to this problem is that failure, even when it is not a crime, is rewarded with golden
parachutes and immoral levels of executive compensation that do not discourage reckless
management and strategies.
The best solution is not prison except in the
case of violent offenders or persons likely to flee to nations that will not extradite
them back to the United States. Assign long prison sentences to all perpetrators who
do not return their ill-gotten gains to victims of their crimes.
In all other instances, the best solution is
enforcement of lifestyle. Force the perpetrators to live out the rest of their lives
at minimum wage jobs until they reach the age of 65. Then make them live only on
Social Security benefits.
What makes matters worse is that the accounting
profession is now seen as helping criminals get away with misdeeds.
A survey of Canadian business executives shows
immense support for auditing reforms. Find out what reforms scored highest on their list. http://www.accountingweb.com/item/70425
I vote for monetary
fine in place of time outs!
"Wall St. Turns to
the Time Out as
Punishment," by Jenny
Anderson, The New York
Times, December 8, 2004
--- http://www.nytimes.com/2004/12/08/business/08wall.html
Regulators
are wielding a new weapon
against Wall Street firms
in the hope that it might
hurt more than
multimillion-dollar fines:
temporarily shutting down
certain business lines.
Last
week, NASD prohibited Merrill
Lynch and Wachovia
Securities from
registering brokers for
five business days on top
of fining the firms: $1.6
million for Merrill Lynch
and $650,000 for Wachovia.
Each firm had failed to
report to NASD on-time
information including
customer complaints,
regulatory actions and
criminal charges and
convictions about its
brokers. Twenty-seven
other firms were charged
with the same late
reporting, but Merrill and
Wachovia faced the
five-day suspension for
both the sheer number of
reporting violations as
well as the two firms'
track record of regulatory
actions.
Merrill
and Wachovia were not the
first to incite the
regulators' ire over late
reporting. In July, Morgan
Stanley was fined $2.2
million for being late
with more than 1,800
incidents of late
reporting about its
brokers. NASD imposed a
five-day suspension for
registering new brokers,
saying in a public
statement that the
severity of the punishment
was related to the number
of late filings and the
fact that the tardiness
impaired its ability to
conduct other
investigations. Wachovia,
Merrill and Morgan Stanley
all agreed to the
sanctions while neither
admitting nor denying the
allegations.
Continued in the
article
"WHITE-COLLAR CRIMINALS Enough Is Enough They lie they cheat they
steal and they've been getting away with it for too long."
Clifton Leaf, Fortune magazine, March 18, 2002, pp.
60-78 --- http://www.fortune.com/indexw.jhtml?channel=artcol.jhtml&doc_id=206659&_DARGS=%2Fhtml%2Fmag_archive%2Fmag_archive_index.html.6_A&_DAV=Home
The Odds Against Doing Time
Regulators like to talk tough, but when it comes to actual
punishment,
all but a handful of Wall Street cheats get off with a slap on the
wrist.
| What Really Happens (From Fortune,
March 18, 2002, p. 72)
In the ten-year period from 1992 to
2001, SEC officials felt that 609 of its civil cases were
egregious enough to merit criminal charges. These were referred
to U.S. Attorneys.
Of the initial 609 referrals, U.S.
Attorneys have disposed of 525
Defendants prosecuted 187
Found guilty 142
Went to jail 87
|
609
525
187
142
87
|
Feeling
cynical?
|
If you aren’t now, you will by the time you finish the new Bebchuk and Fried
paper on executive compensation. They
paint a fairly gloomy picture of managers exerting their power to “extract
rents and to camouflage the extent of their rent extraction.”
Rather than designed to solve agency cost problems, the paper makes the
case that executive pay can by an agency cost in and of itself.
Let’s hope things aren’t this bad.
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=364220
They
say that patriotism is the last refuge
To which a scoundrel clings.
Steal a little and they throw you in jail,
Steal a lot and they make you king.
There's only one step down from here, baby,
It's called the land of permanent bliss.
What's a sweetheart like you doin' in a dump like this?
Lyrics of a Bob Dylan song forwarded by Amian Gadal [DGADAL@CI.SANTA-BARBARA.CA.US] |
"The Accounting Cycle Does Senator Enzi Support Accounting Lies?
by J. Edward Ketz, SmartPros, November 24, 2003 --- http://www.smartpros.com/x41471.xml
I continue to find amazing some public
statements enunciated by members of Congress. It reminds me of the
witticism to be sure that your brain is engaged before putting your
mouth into gear.
Consider recent comments by Senator Mike Enzi
(R-Wyoming), who is holding hearings to allow small business executives
to spout off against accounting reform. Specifically, these managers are
yet again attempting to thwart the the Financial Accounting Standards
Board's efforts to require the expensing of stock-based compensation. Of
course, they covet the privilege of abusing corporate resources instead
of acting as good stewards for the owners -- the stockholders of the
business enterprise.
The Washington Post reports that the senator
berated the chairman of the FASB Robert Herz with the comment,
"I’m hoping small businesses don’t have to wage an 11th-hour
campaign to get FASB to listen." He also chided Herz to contemplate
the effects upon small businesses. Oddly, the senator didn’t advise
Herz to ask investors and creditors about the consequences of poor and
reprehensible accounting practices.
These corporate officials provide no new
arguments or theories to bolster their claims, but rely on vacuous
assertions. They claim that expensing options will hurt their search for
talented managers, but cannot generate any evidence to that effect.
Given that Microsoft now expenses stock-based compensation and appears
not to have troubles hiring good people, I believe the assertion false.
Continued in the article
March 2004 Update
From The American Assembly --- http://www.hypermediative-dev1.net/index.php
The Future of the Accounting Profession --- http://snipurl.com/AccountingFuture
What Went Wrong?
As the bubble economy encouraged corporate management to adopt increasingly
creative accounting practices to deliver the kind of predictable and robust
earnings and revenue growth demanded by investors, governance fell by the
wayside. All too often, those whose mandate was to act as a gatekeeper were
tempted by misguided compensation policies to forfeit their autonomy and
independence. The technology stock bubble of the late 1990s – and the
puncturing of that bubble in 2000 – coincided with significant failures in
corporate governance.
Preface
On November 13, 2003, fifty-seven men and women, including leaders from the
worlds of accounting, finance, law, academia, investment banking, journalism,
non-governmental organizations, as well as the current and former regulatory
officials from The Federal Reserve Board, the Securities and Exchange Commission
(SEC), the General Accounting Office (GAO), the Public Company Accounting
Oversight Board (PCAOB), The Financial Accounting Standards Board (FASB), and
the International Accounting Standards Board (IASB) gathered at the Lansdowne
Resort, Leesburg, Virginia, for the 103rd American Assembly entitled “The
Future of the Accounting Profession.” Over the course of the Assembly, the
distinguished professionals considered three broad areas of the accounting
profession: its present state, its desired future state, and how it might reach
that future state.
This Assembly project was co-directed by Roderick M.
Hills, Partner, Hills & Stern, and former Chairman of the SEC, and Russell
E. Palmer, CEO, The Palmer Group, former CEO, Touche Ross & Co. Initiated by
the co-directors in fall 2000, this project showed an extraordinary prescience
of the material events that subsequently unfolded. The project benefited greatly
from the advice and active guidance of an eminent steering committee, whose
names and affiliations are listed in the appendix of this report.
There are too many conclusions and recommendations to summarize
concisely. Several that caught my eye are as follows:
Accounting firms must seek out job candidates with a
strong knowledge of business and finance. We believe that the Big Four.
Accounting firms must seek out job candidates with a strong knowledge of
business and finance. We believe that the Big Four
The consolidation of the accounting industry has come
at a cost for the profession. With fewer alternatives, companies may have few
options to their current auditors. This may be a situation that is difficult to
correct, but it is one that demands that regulators seek to maintain public
confidence in the surviving Big Four accounting firms, and where auditing firms
themselves strive to overcome the limitations created by their market dominance.
To remain a profession, auditors need to address issues
ranging from the potential problems or conflicts created by the consolidation of
their industry to the need to restore their credibility to attract the ‘best
and the brightest’ of college graduates.
Auditing firms must place the appropriate value on the
partners who conduct top-quality audits, not solely on those ‘rainmakers’
who bring in the most new business. The goal must be to maintain topnotch
auditing standards.
Bob Jensen's Conclusions
The names of the participants are included in the above final
report. Given the tremendous amount of talent and experience of this
group, I was disappointed in the rather unimaginative conclusions.
In the end, a song came to mind with the lyrics "Is that all there
is?"
What is wrong with the report it that it is like focusing on medical
doctors to correct the exploding problem of diabetes, prostate cancer, and
breast cancer in urban society. Another analogy would be to focus on
the police to correct the problem of crime in large U.S. Cities or the
Border Patrol to stop the rising tide of illegal immigration in the United
States.
The recent flood of scandals in the accounting, tax, and auditing
professions were inevitable in the growing sickness of urban society and
culture where families more pride in money than in honor and/or the
breakdown of family infrastructure altogether. Honesty begins at
home. If home fails, then honesty is forced by the sanctions
imposed by strict law enforcement such as we find in very few societies
other than Singapore. Law enforcement has not broken down in the
United States, which is one of the major factors that makes the U.S. a
better place to live than in many other nations. But many
think that we are now fighting a losing battle.
But law enforcement is broken when it comes to white collar crime in
nearly all nations of the world and especially in the United States.
Business leaders violate the laws and push unethical behavior to the edge
because these shameful acts pay big time even in the unlikely event they
will be caught.
Conclusions that are lacking in the above report include the following
conclusion by Bob Jensen:
Unmentioned Recommendation 1
The accounting profession must develop a strategy and funding to combat
white collar crime and tax evasion where it will do the most good in
modern times. There are many fronts on which this war can be
fought, including the following:
- Commence a major lobbying effort and media blitz to promote stiff
penalties that will discourage white collar crime and ethics
violations. Instead of lobbying against
corruption-preventative like tax shelters legislation, the
accountancy profession should undertake an expensive lobbying effort
to curb the crimes of their clients and punish the wrong doers in
ways that effectively discouraging wrong doing. For one thing,
wrong doers should be required to recompense the victims of their
crimes for the rest of their lives such that the wrongdoers cannot
emerge from bankruptcy and/or Club Fed and live a life of luxury
while their victims wallow in poverty.
- Just as important as stiffer penalties are the curbing abuses used
by white collar criminals to not be indicted. For example,
Tyco's CEO and other executives were allowed to appoint their
co-conspirators to Boards of Directors who then approved those
executive's ploys to loot the corporations for personal gain.
The entire process of appointing Boards of Directors and Audit
Committees is flawed in favor of white collar criminals at the
executive level.
- Instead of lobbying for abusive tax shelters in Washington DC, all
accountancy lobbying resources should be aimed at eliminating tax
shelters even though elimination of tax shelters results in lower
client fees.
- Commence a major lobbying effort that encourages and rewards
whistle blowing both in client firms and in auditing firms.
Unmentioned Recommendation 2
Make all persons in society accountable for their resources and life
styles. One means of doing this is doing this is to eliminate cash
in all economic affairs. Every economic transaction should be
accompanied by an auditable trail. A cashless society that is now
technologically feasible is one way to start. The accounting
profession should commence to seriously lobby for a cashless society.
I guess what I am really trying to say is that the accounting
profession will never solve the problems that are emerging without solving
the causes of those underlying problems. Medical doctors cannot stop
the rising tide of diabetes without devoting their professional efforts
and resources to changing life styles, food quality, and eating trends in
modern society. Juvenile crime and drug addiction cannot be solved
without creating economic incentives to strengthen family values and
parental controls. White collar crime cannot be solved without
providing genuine preventative measures aimed at the root causes.
March 5, 2004 reply from Roger Collins [rcollins@CARIBOO.BC.CA]
Bob, in response to your challenge - under
Unmentioned recommendation 1 you say that
the accountancy profession should undertake an
expensive lobbying effort to curb the crimes of their clients
Did you mean "expensive" -
"extensive" or perhaps both ? :-)
One other thought. White collar crime seems to
be so ubiquitous these days that its almost an alternative career path;
if you get caught, its Club Fed; when you've done your time, it could
well be back to your cosy little niche in the business pantheon. Maybe
the powers that be should consider a more creative sentencing regime
that separates these crooks from their place in society. I suppose that
we won't get the chance to bring back the stocks or the pillory - but
instead of 5 years in the (play) pen at taxpayer expense, how about
twenty years at the neighbourhood car wash or sewage farm, accompanied
by compulsory relocation to one of the "nicer" inner-city
neighbourhoods (Watts, say, or Cook county)? As I said, just a thought
... :-)
Roger
March 5, 2004 reply from Dennis Beresford [dberesfo@TERRY.UGA.EDU]
Roger's comments about light sentences for
corporate fraud crimes reminded me of a session I attended last week on
governance matters. One of the speakers was a retired federal judge. He
showed a copy of the sentencing guidelines for various federal crimes
and noted that those guidelines provide for potential prison terms for
Sarbanes-Oxley type crimes that are longer than for murder.
Denny Beresford
March 6, 2004 reply from Bob Jensen
Hi Denny,
If the odds are 99-1 that you won’t get caught and 10-1 that you can
plea bargain down to no jail time, the expected value of a $1 million
heist is pretty high.
After after seeing the light sentences (e.g., Fastow got the
"huge" ten years and Waksal got eight years), the new Sarbanes
guidelines are a welcome relief. However, the National Association of
Defense Lawyers, a very powerful lobbying group, is still in there
fighting against tough sentences and for loopholes. Spit will most
likely freeze in the Mojave Desert the day that any non-violent CEO or CFO
gets more than 10 years in Club Fed in spite of the sentencing guidelines.
The Association of Defense Lawyers wrote the following in a lobbying
letter --- http://snipurl.com/DefenseLawyers
Note that a $1 million theft may ultimately get
you “41-51” months.
Given that the statutory maximum constraints on
the offense levels have been substantially revised by the Congress via
Sarbanes-Oxley, the current loss table, supplemented by
carefully-tailored specific offense characteristic enhancements
(including those in the proposed permanent amendments), will more than
adequately punish those offenders who operate at the highest levels of
economic crime. Many of the offenses potentially affected by a wholesale
revision of the loss table involve criminal statutes and scenarios
untouched by the Sarbanes-Oxley amendments. Most of the cases affected
by the economic guidelines and loss table involve individual defendants
who are low-to-mid-level employees who engage in some unremarkable fraud
scheme or involve defendants who are not corporate employees at all.
There is no suggestion in either the legislative history or the
statutory directive that Sarbanes-Oxley was designed to increase
sentences for garden-variety fraud or economic offenses, much less those
offenses subject to the application of the loss table that do not
involve corporate crime. Nor is there any basis or proof to suggest that
the current guidelines are not acting as severe enough penalty for, or
deterrent to, criminal conduct. A generalized request to “get tough”
on crime, arising in the middle of any wave of media stories about
corporate or other types of wrongdoing should not be the grounds for
changing sentences or guidelines. Indeed, it is precisely in times of
passion and emotion that statutes and rules, including those addressing
penalties and sentences, should remain constant so that balances that
have been carefully struck over time are not tipped for the excitement
of the moment.
. . .
The incremental increases in offense levels at
the higher end of the consolidated theft and fraud table instituted via
the ECP significantly exceed those of their previous separate tables. For
example, a $1 million loss in year 2000, even with application of the
more than minimal planning offense characteristic, would result in a
30-37 month sentencing range; in contrast, the same offender after the
implementation of the ECP loss tables is subject to a 41-51 month range,
an approximately 25% increase. Thus, the
upward trend will accelerate over the next few years as the sentence
increases built into the ECP begin to take effect.
There are times in life when the project at hand calls for the
"bigger hammer" --- http://www.biggerhammer.net/
March 6, 2004 reply from Dave Storhaug [storhaug@BTINET.NET]
In my humble opinion, no true reform will occur
until the accounting profession is split into two groups: 1. SEC / Big 4
and 2. Non SEC and NON Big 4 - which is where the true original spirit
of the CPA profession still resides. (Note that the "BIG 4"
don't even have the words "Public accounting" in theirs names
anymore).
Dave Storhaug Bismarck, ND
March 5, 2004 reply from Todd Boyle [tboyle@ROSEHILL.NET]
1. Transaction semantics.
Until accountants agree on unambiguous
semantics at the transaction level, there is little hope. Transactions
happen between principal parties. Do you call them, parties, persons? or
call them by their roles, buyer, seller? This is an example of a few
hundred concepts that need accountants' participation and discussion.
Until we get on the same page with descriptive
semantics, there is no hope of having an honest set of books, that
agrees with the counterparty in exchanges, let alone, honest financial
statements. See Bill McCarthy's stuff. http://www.msu.edu/user/mccarth4/
and efforts such as UBL, ebXML, as well as newer work of edifact, and
x12.
2. Drilldown.
Stakeholders should be entitled to drill down
into the numbers in financial statements of publicly listed
corporations, period. We need a freedom of information act (FOIA) but
meanwhile accountants might lend a hand, ensuring that what is in the
financial statements is more objectively tied to the native transaction
semantics that arise between the principals in the transactions, instead
of our high-fallutin, abstract summary buckets.
3. Externalities.
A good case can be made that today's
transaction records are essentially, incomplete. (I would not be so
charitable! ) A seller of goods or services is rewarded for what they
deliver, and rewarded for avoiding and minimizing their costs. Only
those persons having some physical power or role to get paid, are paid.
Costs to the commons are not paid. Costs to future generations or
faraway people, are not paid, nor, the harms or costs inflicted on
people who do not have recognized title, within our monolithic global
title system, to be paid.
When I was in school in the 1970s there was a
lot of discussion about social costs and externalities. I think this is
an essential element in accounting reform, if financial statements are
to be viewed as anything other than sophisticated lies, to protect the
interests of the powerful and the privileged.
Accountants maintaining the GAAP framework need
to admit the truth: economic substance includes more than the systems of
title and commercial law in each jurisdiction.
Can't we contribute, with other professions,
towards a conceptual framework for economic substance of commons, like
the environment? That alone would be a priceless contribution. Today's
decisions, based on incomplete quantitative models, are doing
immeasurable harm.
Another candidate for increased work would be
measurement of economic costs, of disenfranchised stakeholders in
economic processes such as workers. There are other categories of
unacknowledged and unrecorded economic advantage.
There is a worldwide anti-globalization
movement. Their basic message is that corporations should not move
operations wherever protections for labor and the environment are most
underdeveloped. The delta between such things as environmental
compliance costs, pension and health benefits in different jurisdictions
is a rich source of quantitative bases for improved financial
statements.
The other broad complaint of anti-globalization
concerns income inequality. Here again, accountants are in a position to
help, with transparency. Transparency invariably results in greater
fairness and freer competition.
In summary let's take a step back from the
transactions records, long enough to realize, they are so incomplete as
to be essentially, a sophisticated lie. A self-serving fairy tale,
accurate to the penny with the quantities agreed by arms-length haggling
between the powerful, while excluding material interests of other
stakeholders.
When the very numbers in your bank account are
a lie, is it any wonder the financial statements of the global 500
corporations are a lie?
Todd Boyle ex-CPA
Kirkland WA - 425-827-3107
http://www.ledgerism.net/
, http://refusenik.org
CEOs gain from poor
performance of share prices
Limiting
severance pay for chief
executives has been an
increasingly popular idea
among investors. Shareholder
proposals like Mr.
Chevedden's went to a vote
at 21 companies last year
and received an average of
51 percent of the
votes. But AMR was not
going to let its
shareholders vote on the
matter just because it may
have seemed to be what
investors wanted. No, AMR
officials first wanted to
make sure that Mr. Chevedden
was still eligible to put
something on the ballot. So
it checked to see how much
his shares were worth.
As it turned out, AMR has
performed so poorly in the
last few years - the price
of its stock has fallen
about 70 percent since
mid-2001 - that Mr.
Chevedden's 100 shares are
now worth just $900. And
that is well below the
$2,000 minimum stake the
S.E.C. says a shareholder
must have if he or she wants
to make a proxy
proposal. AMR asked
the regulators for
permission to exclude Mr.
Chevedden's suggestion for
that reason. The company
even provided evidence of
how weak its stock has been
lately. Last month,
Mr. Chevedden complained to
regulators that AMR was
"implicitly bragging
about the declining
price" of its stock,
and he appealed to their
sense of fairness. He asked
them not to use the
ownership requirements to
"disenfranchise
long-term continuous
shareholders" simply
because "the company
stock price has
sunk." But rules
are rules, so the commission
sided with AMR. An AMR
spokesman said that the
company had no choice but to
disqualify Mr. Chevedden.
Patrick McGeehan, "The
Fine Print Keeps Small
Investors Silent," The
New York Times, March
13, 2005 --- http://www.nytimes.com/2005/03/13/business/yourmoney/13agenda.html
Question
What is moral hazard? How is a new reward policy by Microsoft creating
moral hazard?
Answer
Moral hazard arises when a system or policy within government,
corporations, families, law, or elsewhere creates an opportunity to gain
from being immoral and/or unethical. In many cases the hazard
invites an illegal act for personal gain. The best known moral
hazard is an insurance contract. For example, during the S&L
crisis it was reported that some owners of luxury cars who had lost their
jobs and could no longer afford high car payments were leaving them parked
on San Antonio streets in high crime areas with the keys in the car.
This was an open invitation to have the cars stolen just to collect
insurance money in a city where thousands of cars are stolen each month
and disappear south of the Rio Grande.
Where's the moral hazard? The moral hazard arises when it was
more profitable to simply collect insurance money than to take the time,
cost, and risk of selling in a down market. Arson is frequently
committed because of the moral hazard of fire insurance. Life
insurance sometimes creates a moral hazard for murder or faked suicide.
Much of the recent looting of corporations by top management was caused
by moral hazard arising from lax oversight by "gatekeepers" such
as auditors, audit committees, and boards of directors. Lax
punishment of white collar crime is a huge source of moral hazard --- http://www.trinity.edu/rjensen/fraudconclusion.htm#CrimePays
Another similar type of moral hazard is caused by lax law
enforcement. Near the south Texas border, children from Mexico who
steal vehicles in Texas are seldom prosecuted. Instead they are
returned to Mexico and reappear the next day attempting to steal more
vehicles. Adults use very young children in organized gangs because
children are less likely to be prosecuted.
Microsoft is creating somewhat of a moral hazard with a new policy of
offering rewards for the capture of hackers. The reward $250,000 is
probably pretty good pay for teenagers in countries where penalties are
very lax for first-time teenage offenders. Germany is one of those
countries with lax penalties.
If I were a teenager hacker in Germany, I
might think about raising some hell for Microsoft and then have my friends
or parents turn me in for the reward. Chances for probation are very
high, and the reward collected may be enough to finance my college
education.
It is not clear that Microsoft really
"won one."
"In Virus Wars, Microsoft
Wins One," by Nick Wingfield, The Wall Street Journal, May 10,
2004, Page A3 --- http://online.wsj.com/article/0,,SB108401726263605863,00.html?mod=home_whats_news_us
Firm's Cash-Reward Offer Yields Its First Arrest
Sasser Suspect in Germany
Microsoft
Corp. claimed a breakthrough in the war against computer viruses,
after the software company's cash-reward program led to the arrest of a
German teenager believed to be responsible for the disruptive "Sasser"
and "Netsky" programs.
After a whirlwind three-day
effort to validate a tip from informants, authorities in the German
state of Lower Saxony on Friday arrested an 18-year-old engineering
student at a local technical school. The suspect, who wasn't identified
by name, later confessed, German police said.
Microsoft said its Munich offices
received the tip by telephone from acquaintances of the suspect.
Executives at the Redmond, Wash., company said the informants will
together collect a $250,000 reward from Microsoft if the suspect is
convicted. The company wouldn't identify the informants or give much
additional information about them, other than to say there was more than
one person and fewer than five.
"For us, this is something
of a defining moment in demonstrating our ability to combat malicious
code in collaboration with the authorities," said Brad Smith,
Microsoft senior vice president and general counsel.
The arrest is the first time a
suspect has been nabbed under a reward program that Microsoft launched
in November, setting up a $5 million fund, in conjunction with Interpol,
the Federal Bureau of Investigation and the Secret Service. Writers of
viruses, worms and other disruptive programs typically target computers
running Microsoft's dominant Windows operating system and other
software. The increasingly debilitating impact of the malicious programs
has started to hurt Microsoft's software sales to corporations.
Security flaws in its software
have proved difficult for Microsoft to eliminate. But if more hackers
prove willing to snitch on each other for money, virus writers could be
deterred by the threat of jail time from releasing their creations.
Files found on suspects' computers also could lead to additional
arrests, and provide other information to help security experts block
malicious code.
Sasser began infecting computers
across the Internet just over a week ago. Unlike other malicious
programs, which typically infect computers after users click on
attachments to e-mail messages, Sasser doesn't require a user to take
any action. Instead, the worm scans the Internet for vulnerable
computers, infects them and uses those machines to search for other
potential targets. Sasser doesn't erase files on a user's computer, but
it does slow down computers, causing them to crash in some cases.
Security experts believe Sasser
has infected millions of computers globally on the Internet. Last week,
it infected a third of Taiwan's post-office branches, and 20 British
Airways flights were each delayed about 10 minutes Tuesday due to Sasser
troubles at check-in desks, according to the Associated Press.
Despite the arrest of its
suspected creator, Sasser is expected to continue its disruptions.
"It's a bit like Pandora's box -- once the box has been opened, you
can never put it away," said Graham Cluley, a senior technology
consultant at Sophos Inc., a security software firm in Lynnfield, Mass.
"We believe the worm will carry on infecting people for months to
come."
Early yesterday, not long after
the German suspect's arrest was announced, a new variant of the Sasser
began infecting computers in Portugal, France and other European
countries, according to executives at PandaLabs, a security software
firm. "This fact confirms our fears that he is not the only person
programming the Sasser and Netsky worms, but rather it is an organized
group of delinquents," said Luis Corrons, head of PandaLabs.
Security experts had previously
suspected that a group called Skynet was responsible for both Sasser and
Netsky, a program released early this year that has been followed by
many variants. A message contained in a recent variant, Netsky.AC,
claimed responsibility for the group.
Microsoft said it received the
tip Wednesday from the informants, who were aware of the reward program.
Company investigators in Europe and the U.S. began working feverishly to
verify technical information provided by its informants to prove that
the suspect was the creator of the Sasser worm, the company said. Once
it verified the information from the informants, which it declined to
describe, Microsoft said it notified German police.
Continued in the article
|
