|
The module about Enron in 1995 reads as follows:
Enron's Political Profit Pipeline
In early 1995, the world's biggest natural gas
company began clearing ground 100 miles south of Bombay, India
for a $2.8 billion, gas-fired power plant -- the largest single foreign
investment in India.
Villagers claimed that the power plant was
overpriced and that its effluent would destroy their fisheries and coconut
and mango trees. One villager opposing Enron put it succinctly, "Why
not remove them before they remove us?"
As Pratap Chatterjee reported ["Enron Deal
Blows a Fuse," Multinational Monitor, July/August 1995],
hundreds of villagers stormed the site that was being prepared for Enron's
2,015-megawatt plant in May 1995, injuring numerous construction workers and
three foreign advisers.
After winning Maharashtra state elections, the
conservative nationalistic Bharatiya Janata Party canceled the deal, sending
shock waves through Western businesses with investments in India.
Maharashtra officials said they acted to prevent
the Houston, Texas-based company from making huge profits off "the
backs of India's poor." New Delhi's Hindustan Times
editorialized in June 1995, "It is time the West realized that India is
not a banana republic which has to dance to the tune of
multinationals."
Enron officials are not so sure. Hoping to convert
the cancellation into a temporary setback, the company launched an all-out
campaign to get the deal back on track. In late November 1995, the campaign
was showing signs of success, although progress was taking a toll on the
handsome rate of return that Enron landed in the first deal. In India, Enron
is now being scrutinized by the public, which is demanding contracts
reflecting market rates. But it's a big world.
In November 1995, the company announced that it has
signed a $700 million deal to build a gas pipeline from Mozambique to South
Africa. The pipeline will service Mozambique's Pande gas field, which will
produce an estimated two trillion cubic feet of gas.
The deal, in which Enron beat out South Africa's
state petroleum company Sasol, sparked controversy in Africa following
reports that the Clinton administration, including the U.S. Agency for
International Development, the U.S. Embassy and even National Security
adviser Anthony Lake, lobbied Mozambique on behalf of Enron.
"There were outright threats to withhold
development funds if we didn't sign, and sign soon," John Kachamila,
Mozambique's natural resources minister, told the Houston Chronicle. Enron
spokesperson Diane Bazelides declined to comment on the these allegations,
but said that the U.S. government had been "helpful as it always is
with American companies." Spokesperson Carol Hensley declined to
respond to a hypothetical question about whether or not Enron would approve
of U.S. government threats to cut off aid to a developing nation if the
country did not sign an Enron deal.
Enron has been repeatedly criticized for relying on
political clout rather than low bids to win contracts. Political
heavyweights that Enron has engaged on its behalf include former U.S.
Secretary of State James Baker, former U.S. Commerce Secretary Robert
Mosbacher and retired General Thomas Kelly, U.S. chief of operations in the
1990 Gulf War. Enron's Board includes former Commodities Futures Trading
Commission Chair Wendy Gramm (wife of presidential hopeful Senator Phil
Gramm, R-Texas), former U.S. Deputy Treasury Secretary Charles Walker and
John Wakeham, leader of the House of Lords and former U.K. Energy Secretary.
To this I have added the following
:
From the Free Wall Street Journal
Educators' Reviews for November 1, 2001
TITLE: Enron Did Business With a
Second Entity Operated by Another Company Official; No Public Disclosure Was
Made of Deals
REPORTER: John R. Emshwiller and Rebecca Smith
DATE: Oct 26, 2001
PAGE: C1
LINK: Print Only in the WSJ on October 26, 2001
TOPICS: Disclosure Requirements,
Financial Accounting, Financial Statement Analysis
SUMMARY: Enron's financial statement
disclosures have been less than transparent. Information is arising as the SEC
makes an inquiry into the Company's accounting and reporting practices with
respect to its transactions with entities managed by high-level Enron
managers. Yet, as discussed in a related article, analysts remain confident in
the stock.
QUESTIONS:
1.) Why must companies disclose
related party transactions? What is the significance of the difference between
the wording of SEC rule S-K and FASB Statement of Financial Accounting
Standards No. 57, Related Party Transactions that is cited at the end of the
article?
2.) Explain the logic of why a drop
in investor confidence in Enron's business transactions and reporting
practices could affect the company's credit rating.
3.) Explain how an analyst could
argue, as did one analyst cited in the related article, that he or she is
confident in Enron's ability to "deliver" earnings even if he or she
cannot estimate "where revenues are going to come from" nor where
the company will make profits.
Reviewed By: Judy Beckman, University
of Rhode Island
Reviewed By: Benson Wier, Virginia
Commonwealth University
Reviewed By: Kimberly Dunn, Florida
Atlantic University
--- RELATED ARTICLES ---
TITLE: Heard on the Street: Most
Analysts Remain Plugged In to Enron
REPORTER: Susanne Craig and Jonathan Weil
PAGE: C1
ISSUE: Oct 26, 2001
LINK: http://interactive.wsj.com/archive/retrieve.cgi?id=SB1004043182760447600.djm
TITLE: Enron Officials Sell Shares
Amid Stock-Price Slump
REPORTER: Theo Francis and Cassell Bryan-Low
PAGE: C14
ISSUE: Oct 26, 2001
LINK: http://interactive.wsj.com/archive/retrieve.cgi?id=SB1004043341423453040.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: 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
SUMMARY: Critics argue that Arthur
Andersen LLP has failed to ensure that Enron Corp.'s financial disclosures are
understandable. Enron is currently undergoing SEC investigation and is being
sued by shareholders. Questions relate to disclosure quality and auditor
responsibility.
QUESTIONS:
1.) The article suggests that the
auditor has the job of making sure that financial statements are
understandable and accurate and complete in all material respects. Does the
auditor bear this responsibility? Discuss the role of the auditor in financial
reporting.
2.) One allegation is that Enron's
financial statements are not understandable. Should users be required to have
specialized training to be able to understand financial statements? Should the
financial statements be prepared so that only a minimal level of business
knowledge is required? What are the implications of the target audience on
financial statement preparation?
3.) Enron is facing several
shareholder lawsuits ; however, Arthur Anderson LLP is not a defendant. What
liability does the auditor have to shareholders of client firms? What are
possible reasons that Arthur Anderson is not a defendant in the Enron cases?
4.) What is the role of the SEC in
the investigation? What power does the SEC have to penalize Enron Corp. and
Arthur Anderson LLP?
SMALL GROUP ASSIGNMENT: Should
financial statements be understandable to users with only general business
knowledge? Prepare an argument to support your position.
Reviewed By: Judy Beckman, University
of Rhode Island
Reviewed By: Benson Wier, Virginia Commonwealth University
Reviewed By: Kimberly Dunn, Florida Atlantic University
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
|
Hi John,
There are some activists with a much longer and stronger record of
lamenting the decline in professionalism in auditing and accounting. For some
reason, they are not being quoted in the media at the moment, and that is a
darn shame!
The most notable activist is Abraham Briloff (emeritus from SUNY-Baruch)
who for years wrote a column for Barrons that constantly analyzed
breaches of ethics and audit professionalism among CPA firms. His most famous
book is called Unaccountable Accounting.
You might enjoy "The AICPA's Prosecution of Dr. Abraham Briloff: Some
Observations," by Dwight M. Owsen --- http://accounting.rutgers.edu/raw/aaa/pi/newsletr/spring99/item07.htm
I think Briloff was trying to save the profession from what it is now going
through in the wake of the Enron scandal.
I suspect that the fear of activists (other than Briloff) is that
complaining too loudly will lead to a government takeover of auditing. This
in, my viewpoint, would be a disaster, because it does not take industry long
to buy the regulators and turn the regulating agency into an industry
cheerleader. The best way to keep the accounting firms honest is to forget the
SEC and the AICPA and the rest of the establishment and directly make their
mistakes, deceptions, frauds, breakdowns in quality controls expensive to the
entire firms, and that is easier to do if the firms are in the private sector!
We are seeing that now in the case of Andersen --- in the end its the tort
lawyers who clean up the town.
The problem with most activists against the private sector is that they've
not got much to rely upon except appeals for government intervention. That's
like asking pimps, whores, and Wendy Gramm to clean up town. You can
read more about how Wendy Gramm sold her soul to Enron at http://www.trinity.edu/rjensen/fraud.htm#Farm
Bob Jensen
Click on the above link to view a thirty-minute archived webcast
on the AICPA's newly adopted rules.
After you view this webcast, we invite you to participate on
December 4 at 1 p.m. (Eastern Standard Time) in a live, interactive
web conference. During that web conference, a panel consisting of
representatives from the AICPA Professional Ethics Executive
Committee, the AICPA Ethics and State Societies and Regulatory
Affairs divisions and NASBA will address your questions about the
rules.
Please provide us your questions via e-mail after viewing the archived
webcast. We will respond to those questions during the live
webcast on December 4.
To view/register for the live webcast on December 4, click the
"live webcast" button located on the AICPA
Video Player.
The FASB also has a video that focuses
on the supreme importance of independence in the CPA
profession.
FASB 40-Minute Video, Financially
Correct (Quality of Earnings)
The price is $15.
|
Updates on Enron's Creative
Accounting
Scandal --- http://www.trinity.edu/rjensen/fraud.htm
Big Five firm Andersen is in the thick
of a controversy involving a 20% overstatement in Enron's net earnings and
financial statements dating back to 1997 that will have to be restated. http://www.accountingweb.com/item/63352
One of the main
causes for the restatements of financial reports that will be required of
Enron relates to transactions in which Enron issued shares of its own stock in
exchange for notes receivable. The notes were recorded as assets on the
company books, and the stock was recorded as equity. However, Lynn Turner,
former SEC chief accountant, points out, "It is basic accounting that you
don't record equity until you get cash, and a note doesn't count as cash. The
question that raises is: How did both partners and the manager on this audit
miss this simple Accounting 101 rule?"
In addition, Enron
has acknowledged overstating its income in the past four years of financial
statements to the tune of $586 million, or 20%. The misstatements reportedly
result from "audit adjustments and reclassifications" that were
proposed by auditors but were determined to be "immaterial."
There is a chance
that such immaterialities will be determined to be unlawful. An SEC accounting
bulletin states that certain adjustments that might fall beneath a materiality
threshold aren't necessarily material if such misstatements, when combined
with other misstatements, render "the financial statements taken as a
whole to be materially misleading."
The recent news of Enron Corp.'s need to restate financial statements
dating back to 1997 as a result of accounting issues missed in Big Five firm
Andersen's audits, has caused the Public Oversight Board to decide to take a
closer look at the peer review process employed by public accounting firms. http://www.accountingweb.com/item/64184
"Andersen Passes Peer Review Accounting Firm Cleared
Despite Finding of Deficiencies," by David S. Hilzenrath, The
Washington Post, January 3, 2002 --- http://www.washingtonpost.com/wp-dyn/articles/A54551-2002Jan2.html
But the review of Andersen reflected the
limitations of the peer-review process, in which each of the so-called Big
Five accounting firms is periodically reviewed by one of the others.
Deloitte's review did not include Andersen's audits of bankrupt energy trader
Enron Corp. -- or any other case in which an audit failure was alleged,
Deloitte partners said yesterday in a conference call with reporters.
. .
Concluding Remarks
In its latest review, Deloitte said Andersen auditors
did not always comply with requirements for communicating with their
overseers on corporate boards. According to Deloitte's report, in a few
instances, Andersen failed to issue a required letter in which auditors
attest that they are independent from the audit client and disclose factors
that might affect their independence.
In a recent letter to the American Institute of
Certified Public Accountants, Andersen said it has addressed the concerns
that Deloitte cited.
|
Deloitte
& Touche in the Hot Seat
"Fugitive
Billions," Washington
Post Editorial, June 3,
2002, Page A14 --- http://www.washingtonpost.com/wp-dyn/articles/A49512-2002Jun2.html
IN
THE AFTERMATH of Enron,
the tarnished auditing
profession has mounted
what might be called the
"complexity
defense." This
involves frowning
seriously, intoning a few
befuddling sentences, then
sighing that audits
involve close-call
judgments that reasonable
experts could debate.
According to this defense,
it isn't fair to beat up
on auditors as they
wrestle with the finer
points of derivatives or
lease receivables -- if
they make calls that are
questionable, that's
because the material is so
difficult. Heck, it's not
as though auditors stand
by dumbly while something
obviously bad happens,
such as money being
siphoned off for the
boss's condo or golf
course.
Really?
Let's look at Adelphia
Communications Corp., the
nation's sixth-largest
cable firm, which is due
to be suspended from the
Nasdaq stock exchange
today. On May 24, three
days after the audit lobby
derailed a Senate attempt
to reform the profession,
Adelphia filed documents
with the Securities and
Exchange Commission that
reveal some of the most
outrageous chicanery in
corporate history. The
Rigas family, which
controlled the company
while owning just a fifth
of it, treated Adelphia
like a piggy bank: It used
it, among other things, to
pay for a private jet,
personal share purchases,
a movie produced by a
Rigas daughter, and (yes!)
a golf course and a
Manhattan apartment. In
all, the family helped
itself to secret loans
from Adelphia amounting to
$3.1 billion. Even Andrew
Fastow, the lead siphon
man at Enron, made off
with a relatively modest
$45 million.
Where
was Deloitte & Touche,
Adelphia's auditor, whose
role was to look out for
the interests of the
nonfamily shareholders who
own four-fifths of the
firm? Deloitte was
apparently inert when
Adelphia paid $26.5
million for timber rights
on land that the family
then bought for about
$500,000 -- a nifty way of
transferring other
shareholders' money into
the Rigas's coffers.
Deloitte was no livelier
when Adelphia made secret
loans of about $130
million to support the
Rigas-owned Buffalo Sabres
hockey team. Deloitte
didn't seem bothered when
Adelphia used smoke and
mirrors to hide debt off
its balance sheet. In sum,
the auditor stood by while
shareholders' cash left
through the front door and
most of the side doors.
There is nothing complex
about this malfeasance.
When
Adelphia's board belatedly
demanded an explanation
from its auditor, it got a
revealing answer. Deloitte
said, yes, it would
explain -- but only on
condition that its
statements not be used
against it. How could
Deloitte have forgotten
that reporting to the
board (and therefore to
the shareholders) is not
some special favor for
which reciprocal
concessions may be
demanded, but rather the
sole reason that auditors
exist? The answer is
familiar. Deloitte forgot
because of conflicts of
interest: While auditing
Adelphia, Deloitte
simultaneously served as
the firm's internal
accountant and as auditor
to other companies
controlled by the Rigas
family. Its real
allegiance was not to the
shareholders but to the
family that robbed them.
It's
too early to judge the
repercussions of Adelphia,
but the omens are not
good. When audit failure
helped to bring down
Enron, similar failures
soon emerged at other
energy companies -- two of
which fired their CEOs
last week. Equally, when
audit failure helped to
bring down Global
Crossing, similar failure
emerged at other telecom
players. Now the worry is
that Adelphia may signal
wider trouble in the cable
industry. The fear of
undiscovered booby traps
is spooking the stock
market: Since the start of
December, when Enron filed
for bankruptcy, almost all
macro-economic news has
been better than expected,
but the S&P 500 index
is down 2 percent.
Without
Enron-Global Crossing-Adelphia,
the stock market almost
certainly would be higher.
If the shares in the New
York Stock Exchange were a
tenth higher, for example,
investors would be
wealthier by about $1.5
trillion. Does anyone in
government care about
this? We may find out when
Congress reconvenes this
week. Sen. Paul Sarbanes,
who sponsored the reform
effort that got derailed
last month, will be trying
to rally his supporters.
Perhaps the thought of
that $1.5 trillion -- or
even Adelphia's fugitive
$3 billion -- will get
their attention.
The above article must be juxtaposed against this earlier Washington Post article:
"Andersen Passes
Peer Review Accounting Firm Cleared Despite Finding of Deficiencies," by
David S. Hilzenrath, The Washington Post, January 3, 2002 --- http://www.washingtonpost.com/wp-dyn/articles/A54551-2002Jan2.html
But
the review of Andersen reflected the limitations of the peer-review process,
in which each of the so-called Big Five accounting firms is periodically
reviewed by one of the others. Deloitte's review did not include Andersen's
audits of bankrupt energy trader Enron Corp. -- or any other case in which
an audit failure was alleged, Deloitte partners said yesterday in a
conference call with reporters.
. .
Concluding Remarks
In its latest review, Deloitte said Andersen auditors
did not always comply with requirements for communicating with their
overseers on corporate boards. According to Deloitte's report, in a few
instances, Andersen failed to issue a required letter in which auditors
attest that they are independent from the audit client and disclose factors
that might affect their independence.
In a recent letter
to the American Institute of Certified Public Accountants, Andersen said it
has addressed the concerns that Deloitte cited.
|
"How to Spot the Next Enron," by George
Anders, Fast Company, December 19, 2007 ---
http://www.fastcompany.com/magazine/58/ganders.html
As cited by Smoleon Sense, on September 23, 2009 ---
http://www.simoleonsense.com/investors-beware-how-to-spot-the-next-enron/
Want to know how to
avoid being fooled by the next too-good-to-be-true stock-market darling?
Just remember these six tips from the cynics of Wall Street, the short
sellers.
If only we could have
spotted the rascals ahead of time. That's the lament of anyone who
bought Enron stock a year ago, or who worked at a now-collapsed company
like Global Crossing or who trusted any corporate forecast that proved
way too upbeat. How could we have let ourselves be fooled? And how do we
make sure that we don't get fooled again?
It's time to visit with
some serious cynics. Some of the shrewdest advice comes from Wall
Street's short sellers, who make money by betting that certain stocks
will fall in price. They had a tough time in the 1990s, when it paid to
be optimistic. But it has been their kind of year. Almost every day, new
accounting jitters rock the stock market. And if you aren't asking about
hidden partnerships and earnings manipulation -- the sort of outrages
that short sellers love to expose -- you risk being blindsided by yet
another business wipeout.
Think of short sellers
as being akin to veteran cops who walk the streets year after year. They
pick up subtle warning signs that most of us miss. They see through
alibis. And they know how to quiz accomplices and witnesses to put
together the whole story, detail by detail. It's nice to live in a world
where we can trust everything we're told because everyone behaves
perfectly. But if the glitzy addresses of Wall Street have given way to
the tough sidewalks of Mean Street these days, we might as well get
smart about the neighborhood.
The first rule of these
streets, says David Rocker, a top New York money manager who has been an
active short seller for more than two decades, is not to get mesmerized
by a charismatic chief executive. "Most CEOs are ultimately salesmen,"
Rocker says. "If they showed up on your doorstep and said, 'I've got a
great vacuum cleaner,' you wouldn't buy it right away. You'd want to see
if it works. It's the same thing with a company."
A legendary case in
point involves John Sculley, former CEO of Apple Computer. In 1993, he
briefly became chief executive of a little wireless data company called
Spectrum Information Technologies and spoke glowingly of its prospects.
Spectrum's stock promptly tripled. But those who had looked closely at
Spectrum's technology weren't nearly as impressed.
Just four months later,
Sculley quit, saying that Spectrum's founders had misled him. The
company restated its earnings, backing away from some aggressive
treatment of licensing revenue that had inflated profits. The stock
crashed. The only ones who came out looking smart were the short sellers
who disregarded the momentary excitement of having a big-name CEO join
the company. Instead, those short sellers focused on the one question
that mattered: Are Spectrum's products any good?
So in the wake of Enron,
you want to know what to look for in other companies. Or, more to the
point, you need to know what to look for in your own company, so you're
not stuck explaining what happened to your missing 401(k) fund. Here are
six basic pointers from the short-selling community.
1. Watch
cash flow, not reported net income. During Enron's heyday
from 1999 to 2000, the company reported very strong net income --
aided, we now know, by dubious accounting exercises. But the actual
amount of cash that Enron's businesses generated wasn't nearly as
impressive. That's no coincidence.
Companies can create
all sorts of adjustments to make net income look artificially strong
-- witness what we've seen so far with Enron and Global Crossing.
But there's only one way to show strong cash flow from operations:
Run the business well.
2. Take a
wary look at acquisition binges. Some of the most
spectacular financial meltdowns of recent years have involved
companies that bought too much, too fast. Cendant, for example, grew
fast in the mid-1990s by snapping up the likes of Days Inn, Century
21, and Avis but overreached when it bought CUC International Inc.,
a direct-marketing firm. Accounting irregularities at CUC led to
massive write-downs in 1997, which sent the combined company's stock
plummeting.
3. Be
mindful of income-accelerating tricks. Conservative
accounting says that long-term contracts should not be treated as
immediate windfalls that shower all of their benefits on today's
financial statements. Sell a three-year magazine subscription, and
you've got predictable obligations until 2005. Those expenses will
slowly flow onto your financial statements -- and it's prudent to
book the income gradually as well.
But in some industries,
aggressive practitioners like to put jumbo profits on the books all at
once. Left for later are worries about how to deal with the eventual
costs of those long-term deals. In a recent Barron's interview, longtime
short seller Jim Chanos identified such "gain on sale" accounting tricks
as a sure sign that the management is being too aggressive for its own
good.
Jensen Comment
Cash flow statements are useful, but they are no panacea replacement of
accrual accounting and earnings analysis. One huge problem is that
unscrupulous executives can more easily manipulate/manage cash flows ---
http://www.trinity.edu/rjensen/theory01.htm#CashVsAccrualAcctg
Question
What do the department store chains WT Grant and Target possibly have in
common?
Answer
WT Grant had a huge chain of
departments stores across the United States. It declared bankruptcy in the
sharp 1973 recession largely because of a build up of accounts receivable
losses. Now in 2008
Target Corporation is in a somewhat
similar bind.
In 1980 Largay and Stickney (Financial Analysts Journal) published a
great comparison of WT Grant's cash flow statements versus income
statements. I used this study for years in some of my accounting courses.
It's a classic for giving students an appreciation of cash flow statements!
The study is discussed and cited (with exhibits) at
http://www.sap-hefte.de/download/dateien/1239/070_leseprobe.pdf
It also shows the limitations of the current ratio in financial analysis and
the problem of inventory buildup when analyzing the reported bottom line net
income.
From The Wall Street Journal Accounting Weekly Review on March 14,
2008
|
IIs
Target Corp.'s Credit Too Generous?
by Peter Eavis
The Wall Street Journal
Mar 11, 2008
Page: C1
Click here to view the full article on
WSJ.com
http://online.wsj.com/article/SB120519491886425757.html?mod=djem_jiewr_AC
TOPICS: Allowance
For Doubtful Accounts, Financial Accounting, Financial Statement
Analysis, Loan Loss Allowance
SUMMARY: "'Target
appears to have pursued very aggressive credit growth at the
wrong time," says William Ryan, consumer-credit analyst at
Portales Partners, a New York-based research firm. "Not so."
says Target's chief financial officer, Douglas Scovanner, "The
growth in the credit-card portfolio is absolutely not a function
of a loosening of credit standards or a lowering of credit
quality in our portfolio."
CLASSROOM APPLICATION: This
article covers details of financial statement ratios used to
analyze Target Corp.'s credit card business. It can be used in a
financial statement analysis course or while covering accounting
for receivables in a financial accounting course
QUESTIONS:
1. (Introductory)
What types of credit cards has Target Corp. issued? Why do
companies such as Target issue these cards?
2. (Introductory)
In general, what concerns analysts about Target Corp.'s
portfolio of receivables on credit cards?
3. (Introductory)
How can a sufficient allowance for uncollectible accounts
alleviate concerns about potential problems in a portfolio of
loans or receivables? What evidence is given in the article
about the status of Target's allowance for uncollectible
accounts?
4. (Advanced)
"...High growth may make it [hard] to see credit deterioration
that already is happening..." What calculation by analyst
William Ryan is described in the article to better "see" this
issue? From where does he obtain the data used in the
calculation? Be specific in your answer.
5. (Advanced)
Refer again to the calculation done by the analyst Mr. Ryan. How
does that calculation resemble the analysis done for an aging of
accounts receivable?
6. (Advanced)
What other financial analysis ratio is used to assess the status
of a credit-card loan portfolio such as Target Corp.'s?
7. (Advanced)
If analysts prove correct in their concern about Target Corp.'s
credit-card receivable balance, what does that say about the
profitability reported in this year? How will it impact next
year's results?
Reviewed By: Judy Beckman, University of Rhode
Island
|
Bob Jensen's threads on the Enron/Worldcom/Andersen frauds ---
http://www.trinity.edu/rjensen/FraudEnron.htm
From The Washington Post,
December 2, 2001 ---
http://www.washingtonpost.com/wp-dyn/articles/A44063-2001Dec1.html
"At Enron, the Fall Came
Quickly: Complexity,
Partnerships Kept Problems From Public View"
By Steven Pearlstein and Peter Behr
Washington Post Staff Writers
Sunday, December 2, 2001; Page A01
Only a year ago,
Ken Lay might have been excused for feeling on top of the world.
The company he
founded 15 years before on the foundation of a sleepy Houston gas pipeline
company had grown into a $100 billion-a-year behemoth, No. 7 on Fortune's
list of the 500 largest corporations, passing the likes of International
Business Machines Corp. and AT&T Corp. The stock market valued Enron
Corp.'s shares at nearly $48 billion, and it would add another $15 billion
before year-end.
Enron owned power
companies in India, China and the Philippines, a water company in Britain,
pulp mills in Canada and gas pipelines across North America and South
America. But those things were ancillary to the high-powered trading rooms
in a gleaming seven-story building in Houston that made it the leading
middleman in nationwide sales of electricity and natural gas. It was primed
to do the same for fiber-optic cable, TV advertising time, wood pulp and
steel. Enron's rise coincided with a stock market boom that made everyone
less likely to question a company if it had "Internet" and
"new" in its business plan.
And, to top it off,
Lay's good friend, Texas Gov. George W. Bush, on whom he and his family had
lavished $2 million in political contributions, had just been elected
president of the United States.
Enron intended to
become "the World's Greatest Company," announced a sign in the
lobby of its Houston headquarters. Lay was widely hailed as a visionary.
A year later, Lay's
empire, and his reputation, are a shambles. Enron's stock is now virtually
worthless. Many of its most prized assets have been pledged to banks and
other creditors to pay some of its estimated $40 billion debt. Company
lawyers are preparing a bankruptcy court filing that is expected to come as
soon as this week and may be the biggest and most complex ever. Most of
Enron's trading customers have gone elsewhere.
Retirement Losses
The company's
21,000 employees have lost much of their retirement savings because their
pension accounts were stuffed with now-worthless Enron stock, and many
expect to lose their jobs as well this coming week. Some of the nation's
biggest mutual-fund companies, including Alliance Capital, Janus, Putnam and
Fidelity, have lost billions of dollars in value.
Meanwhile, the
Securities and Exchange Commission, headed by a Bush appointee, is
investigating the company and its outside auditors at Arthur Andersen, while
the House and Senate energy committees plan hearings.
It will take months
or years to definitively answer the myriad questions raised by Enron's
implosion. Why did it happen, and why so quickly? What did Enron's blue-chip
board of directors and auditors know of the financial shenanigans that
triggered the company's fall when hints of them became public six weeks ago?
Should government regulators have been more vigilant?
Even now, however,
it is clear that Enron was ruined by bad luck, poor investment decisions,
negligible government oversight and an arrogance that led many in the
company to believe that they were unstoppable.
By this fall, a
recession, the dot-com crash and depressed energy prices had taken a heavy
toll on the company's financial strength. The decline finally forced the
company to reveal that it had simply made too many bad investments, taken on
too much debt, assumed too much risk from its trading partners and hidden
much of it from the public.
Such sudden falls
from great heights recur in financial markets. In the late 1980s, its was
junk-bond king Drexel Burnham Lambert. In the 1990s, it was Long Term
Capital Management, the giant hedge fund. Like Enron, Drexel and Long Term
Capital helped create and dominate new markets designed to help businesses
and investors better manage their financial risks. And, like Enron, both
were done in by failing to see the risks that they themselves had taken on.
It was in the
trading rooms where Enron's big profits were made and the full extent of its
ambitions were revealed.
Early on, the
contracts were relatively simple and related to its original pipeline
business: a promise to deliver so many cubic feet of gas to a fertilizer
factory on a particular day at a particular price. But it saw the
possibilities for far more in the deregulation of electric power markets,
which would allow new generating plants running on cheap natural gas to
compete with utilities. Lay and Enron lobbied aggressively to make it
happen. After deregulation, independent power plants and utilities and
industries turned to Enron for contracts to deliver the new electricity.
The essential idea
was hardly new. But unlike traditional commodity exchanges, such as the
Chicago Board of Trade and the New York Mercantile Exchange, Enron was not
merely a broker for the deals, putting together buyers and sellers and
taking transaction fees. In many cases, Enron entered the contract with the
seller and signed a contract with the buyer. Enron made its money on the
difference in the two prices, which were never posted in any newspaper or on
any Web site, or even made available to the buyers and sellers. Enron alone
set them.
By keeping its
trading book secret, Enron was able to develop a feel for the market. And
virtually none of its activity came under federal regulation because Enron
and other power marketers were exempted from oversight in 1992 by the
Commodity Futures Trading Commission -- then headed by Wendy Gramm, who is
now an Enron board member.
Because it was
first in the marketplace and had more products than anyone else, "Enron
was the seller to every buyer and the buyer to every seller," said
Philip K. Verleger Jr., a California energy economist.
The contracts
became increasingly varied and complex. Enron allowed customers to insure
themselves against all sorts of eventualities -- a rise and fall in prices
or interest rates, a change in the weather, the inability of a customer to
pay. By the end, the volume in the financial contracts reached 15 to 20
times the volume of the contracts to actually deliver gas or electricity.
And Enron was employing a small army of PhDs in mathematics, physics and
economics -- even a former astronaut -- to help manage its risk, backed by
computer systems that executives once claimed would take $100 million to
replicate.
Dominant Energy
Supplier
Enron was so
dominant -- it was responsible for one-quarter of the gas and electricity
traded in the United States -- that it became a prime target for California
officials seeking culprits for the energy price shocks last year and this.
It was an image Enron didn't improve by publicly rebuffing a state
legislative subpoena for its trading records.
How much risk Enron
was taking on itself, and how much it was laying off on other parties, was
never revealed. Verleger said last week that Enron once had one of the best
risk-disclosure statements in the energy industry. But once the financial
contracts began to outpace the basic energy contracts, the statements, he
said, suddenly became more opaque. "It was, 'Trust us. We know what
we're doing,' " he said.
None of that,
however, was of much concern to investors and lenders, who saw Enron as the
vanguard of a new industry. New sales and earnings justified an even higher
stock price, still more borrowing and more investment.
By 1997, however,
after lenders began to express concern about the extent of Enron's
indebtedness, chief financial officer Andrew Fastow developed a strategy to
move some of the company's assets and debts to separate private
partnerships, which would engage in trades with Enron. Fastow became the
manager of some of the largest partnerships, with approval of the audit
committee of Enron's board.
Enron's description
of the partnerships were, at best, baffling: "share settled costless
collar arrangements," and "derivative instruments which eliminate
the contingent nature of existing restricted forward contracts." More
significantly, Enron's financial obligations to the partnerships if things
turned sour were not explained.
When Enron released
its year-end financial statements for 2000, questions about the partnerships
were raised by James Chanos, an investor who had placed a large bet that
Enron stock would decline in the ensuing months. Such investors, known as
short sellers, often try to "talk down" a stock, and Enron
executives dismissed Chanos's questions as nothing more than that.
On Oct. 16,
however, it became clear that Chanos was onto something. On that day, Enron
reported a $638 million loss for the third quarter and reduced the value of
the company's equity by $1.2 billion. Some of that was related to losses
suffered by the partnerships, in which Enron had hidden investment losses in
a troubled water-management division, a fiber-optic network and a bankrupt
telecommunications firm. The statement also revealed that the promises made
to the partnerships to guarantee the value of their assets could wind up
costing $3 billion.
Within a week, as
Enron stock plummeted, Fastow was ousted and the Securities and Exchange
Commission began an inquiry. Then, on Nov. 8, bad turned to worse when Enron
announced it was revising financial statements to reduce earnings by $586
million over the past four years, in large part to reflect losses at the
partnerships. It was also disclosed that Fastow made $30 million in fees and
profits from his involvement with the outside partnerships.
The last straw was
Enron's admission that it faced an immediate payment of $690 million in debt
-- catching credit analysts by surprise -- with $6 billion more due within a
year. Fearful that they wouldn't get paid for electricity and gas they sold
to Enron, energy companies began scaling back their trading.
Desperate to
salvage some future for the company, Lay agreed to sell Enron to crosstown
rival Dynegy Inc. for $10 billion in stock. Perhaps more important, Dynegy
agreed to assume $13 billion of Enron's debts and to inject $1.5 billion in
cash to reassure customers and lenders and to keep its operations going. But
when Dynegy officials got a closer look at Enron's books during Thanksgiving
week, it found that the problems were far worse than they had imagined. They
decided the best deal was no deal.
"The story of
Enron is the story of unmitigated pride and arrogance," said Jeffrey
Pfeffer, a professor of organized behavior at Stanford Business School who
has followed the company in recent months. "My impression is that they
thought they knew everything, which [is] always the fatal flaw. No one knows
everything."
As harsh as it is,
that view is shared by many in the energy industry: customers and
competitors, stock analysts who cover the company and politicians and
regulators in Washington and state capitals. In their telling, Enron
officials were bombastic, secretive, boastful, inflexible, lacking in candor
and contemptuous of anyone who didn't agree with their philosophy and
acknowledge their preeminence.
Last month, sitting
in the lobby of New York's Waldorf-Astoria hotel, Lay seemed to acknowledge
that pride may have been a factor in the company's fall. "I just want
to say it was only a few people at Enron that were cocky," he said.
Lay declined to
name them, but most would put Jeffrey Skilling at the top of the list. Lay
tapped Skilling, a whiz kid with the blue-chip consulting firm of McKinsey
& Co. and the architect of Enron's trading business, to succeed him as
chief executive in February.
Shortly after
taking over the top spot, Skilling appeared at a conference of analysts and
investors in San Francisco and lectured the assembled on how Enron's stock,
then at record levels, was undervalued nonetheless because it did not
recognize the company's broadband network, worth $29 billion, or an extra
$37 a share.
Skilling loved
nothing more than to mock executives from old-line gas and electric
utilities or companies that still bought paper from golf-playing salesmen
rather than on EnronOnline.
Skilling once
called a stock analyst an expletive for questioning Enron's policy of
refusing to release an update of its balance sheet with its quarterly
earnings announcement, as nearly every other public corporation does.
Skilling Resigns
In August, after
Enron's stock had fallen by half, Skilling resigned as chief executive after
six months on the job, citing personal reasons.
As for Lay, some
question how much he really understood about the accounting ins and out.
When asked about the partnerships by a reporter in August, he begged off,
saying, "You're getting way over my head."
Lynn Turner, who
recently resigned as chief accountant at the Securities and Exchange
Commission, said Enron's original financial statements for the past three
years involve clear-cut errors under SEC rules that had to have been known
to Enron's auditors at Arthur Andersen.
Turner, now
director of the Center for Quality Financial Reporting at Colorado State
University, said that based on information now reported by the company, he
believes the auditors knew the real story about the partnerships but
declined to force the company to account for them correctly.
Why? "One has
to wonder if a million bucks a week didn't play a role," Turner said.
He was referring to the $52 million a year in fees Andersen received last
year from Enron, its second-largest account, divided almost equally between
auditing work and consulting services.
Anderson spokesman
David Talbot recently described the problems with Enron's books as "an
unfortunate situation."
If Enron's auditors
failed investors, the same might be said for its board of directors -- and,
in particular, the members of the audit committee that is charged with
reviewing the company's financial statements. The committee is headed by
Robert Jaedicke, a former dean of the Stanford University business school
and the author of several accounting textbooks. Members include Paulo Ferrz
Pereira, former president of the State Bank of Rio de Janeiro; John Wakeham,
former head of the British House of Lords who headed a British accounting
firm; and Gramm, the former Commodity Futures Trading Commission chairman.
Wakeham received
$72,000 last year from Enron, in addition to his director's fee, for
consulting advice to the company's European trading office, according to
Enron's annual proxy statement. And Enron has contributed to the center at
George Mason University, where Gramm heads the regulatory studies program.
Charles O'Reilly, a
Stanford University business school professor, said that while such
donations rarely "buy" the cooperation of directors, they do
indicate the problem when chief executives and directors develop a
"pattern of reciprocity" in which they do favors for each other
and gradually become reluctant to rock the boat, particularly on complex
accounting matters.
"Boards of
directors want to give favorable interpretation to events, so even when they
are nervous about something, they are reluctant to make a stink,"
O'Reilly said.
Stock analysts were
equally easy on Enron, despite the company's insistence on putting out
financial statements that, even in Lay's words, were "opaque and
difficult to understand."
Many analysts admit
now that they really didn't know what was going on at the company even as
they continued to recommend the stock to investors. They were rewarded for
it by an ever-rising stock price that seemed to confirm their good judgment.
"It's so
complicated everybody is afraid to raise their hands and say, 'I don't
understand it,' " said Louis B. Gagliardi, an analyst with John S.
Herold Inc. in Norwalk, Conn.
"It wasn't
well understood. At the same time, it should have been. There's a burden on
the analysts. . . . There's guilt to be borne all around here."
"Enron Readies For Layoffs, Legal Battle: Rival Dynegy Sues For
Pipeline Network," The Washington Post, December 3, 2001 --- http://www.washingtonpost.com/wp-dyn/articles/A52318-2001Dec3.html
By Peter Behr Washington Post Staff Writer Tuesday, December 4, 2001; Page
E01
Enron Corp.'s record bankruptcy action rattled its
Houston home base yesterday, as the energy trader prepared to lay off 4,000
headquarters employees and began a bitter legal struggle with Dynegy Inc.,
its neighbor and would-be rescuer, over the causes of its monumental
collapse.
Enron told most of its Houston workers to go home
and await word on whether their jobs were gone. Meanwhile, Dynegy filed a
countersuit against Enron demanding ownership of one of its major pipeline
networks -- an asset Dynegy was promised when it advanced $1.5 billion to
Enron as part of its aborted Nov. 9 takeover agreement.
The legal battle began Sunday, when Enron filed a
$10 billion damage suit against Dynegy, claiming it was forced into a
Chapter 11 bankruptcy proceeding when Dynegy pulled back its purchase offer
following intense negotiations the weekend after Thanksgiving.
Dynegy's chairman and chief executive, Chuck
Watson, said yesterday in a conference call that Enron's lawsuit "is
one more example of Enron's failure to take responsibility for its own
demise."
"Enron's rapid disintegration," he added,
follows "a general loss of public confidence in its leadership and
credibility."
Dynegy's shares fell $3.18, or 10 percent, to
$27.17 yesterday because of investors' fears that the bankruptcy process
will tie up Dynegy's claim to the Omaha-based Northern Natural Gas Co.
pipeline, forcing it to write down the $1.5 billion payment to Enron.
"Dynegy is now entangled in this Enron
mess," said Commerzbank Securities analyst Andre Meade.
"Investors fear the $1.5 billion investment
might not be easily converted into ownership of the pipeline," said Tom
Burnett, president of Merger Insight, an affiliate of Wall Street Access, a
New York-based brokerage and financial adviser.
On the broader impact of Enron's bankruptcy, Donald
E. Powell, chairman of the Federal Deposit Insurance Corp., said in an
interview that regulators believe so far that losses on loans to the ailing
energy company will be painful but not large enough to cause any bank to
fail. However, he said that the ripple effect on other Enron creditors, who
in turn may find it harder to repay bank loans, is more difficult to gauge.
"Enron is a complex company," said
Powell. "It will take some time to digest the consequences to the
banking industry." The FDIC insures deposits at the nation's 9,747
banks and thrifts.
Shares of Enron's major European bank lenders also
fell yesterday on overseas markets.
The stock price of J.P. Morgan Chase, one of
Enron's lead bankers, fell 3 percent, or $1.17, to $36.55. Enron told a
bankruptcy court judge in Manhattan that it has arranged up to $1.5 billion
in financing from J.P. Morgan Chase and Citigroup to keep operating as it
reorganizes under Chapter 11 bankruptcy protection, according to the
Associated Press.
The charges and countercharges between Enron and
Dynegy are the opening rounds in a what legal experts predict will be a
relentless battle between the two Houston companies.
Hundreds of lawyers representing investors and
employees are lining up to question Enron executives and the former Enron
officials who quit or were fired in the past four months as the fortunes of
the powerful energy trading company disintegrated.
Ahead of them are Securities and Exchange
Commission investigators probing whether Enron concealed critical
information about its problems from shareholders. Investigators from the
House Energy and Commerce Committee are headed for Houston this week to
pursue a congressional inquiry into the largest bankruptcy action in U.S.
history.
And in the lead position is U.S. Bankruptcy Judge
Arthur J. Gonzalez in New York, who has sweeping powers under federal law to
oversee claims against Enron, as the company tries to restore its trading
business and settle creditors' claims.
Dynegy's immediate goal is to have the ownership of
the Northern gas pipeline decided in state court in Texas, where the
companies are located, said Dynegy attorney B. Daryl Bristow of Baker Botts.
"Could the bankruptcy court try to put the
brakes on this? They could. We'll be in court trying to stop it from
happening," Bristow said.
A Message from Duncan Williamson [duncan.williamson@TESCO.NET]
I'm sticking my neck out a bit and offering you all
a PDF file I put together on the Enron Affair. I've taken a wide variety of
sources in an attempt to explain where I think we are with this case. What
Enron does (or did), what has happened and so on. It's a sort of position
paper that attempts to explain the facts to non accountants and novice
accountants. It's 24 pages long but doesn't take that much time to download.
I have used materials from messages on this list and hope the authors don't
mind and I have credited them by name. I have used Bob Jensen's bookmarks,
too; as well as a whole host of other things.
I'd be grateful for any comments on this paper, or
even offers of help to improve what I've done. I have to say I did it in a
bit of a hurry and won't be offended by any criticism, providing it's
constructive.
I have tested my links and they work for me: let me
know of any problems, though. It's at http://www.duncanwil.co.uk/pdfs.html
link number 1
Incidentally, if you haven't been to my site
recently (or at all), you can see my latest news at http://www.duncanwil.co.uk/news0212.html
. I have a very nice looking Newsletter waiting for you: complete with Xmas
theme. Please check my home page every week for the latest newsletter as it
is linked from there (take a look now, you'll see what I mean). At the
moment I am managing to add content at a significant rate; and will point
out that I have developed several new features over the last three months or
so, as well as the materials and pages themselves.
My home page (sorry, my Ho! Ho! Home Page) is at http://www.duncanwil.co.uk/index.htm
and is equally festive (well, with a name like Ho! Ho! Home Page it would
have to be, wouldn't it?)
Looking forward to seeing you on line!
Best wishes
Duncan Williamson
"The Internet Didn't Kill Enron," By Robert Preston, Internet
Week, November 30, 2001 --- http://www.internetweek.com/enron113001.htm
"We have a fundamentally better business
model."
That's how Jeffrey Skilling, then president of
Enron Corp., summarized his company's startling ascendancy a year ago, as
Enron's revenues were soaring on the wings of its Internet-based trading
model.
It was hard to find fault with Enron's strategy of
brokering energy and other commodities over the Internet rather than
commanding the means of production and distribution. EnronOnline, its
year-old commodity-trading site, already was handling more than $1 billion a
day in transactions and yielding the bulk of the company's profits. At its
peak, Enron sported a market cap of $80 billion, bigger than all its
competitors combined.
See Also Forum: Enron E-Biz Meltdown: What Went
Wrong? More Enron Stories
Today, Enron is near bankruptcy, the status of
EnronOnline is touch and go, ENE is a penny stock and Skilling is out of a
job. Last year's Fortune 7 wunderkind, hailed by InternetWeek and others as
one of the most innovative companies in America, overextended itself to the
point of insolvency.
So was Enron's "better business model"
fundamentally flawed? With the benefit of 20/20 hindsight, what can
Internet-inspired companies in every industry learn from Enron's demise?
For one thing, complex Internet marketplaces of the
kind Enron assembled are fragile. Enron prospered on the Net not so much
because it had good technology -- though the proprietary EnronOnline
platform is considered leading-edge -- but because online customers trusted
the company to meet its price and delivery promises.
As Skilling told InternetWeek a year ago,
"certainty of execution and certainty of fulfillment are the two things
people worry about with commodity products." Enron, by virtue of its
expertise, networked relationships and reputation, could guarantee those
things.
Once it came to light, however, that Enron was
playing fast with its financials -- doing off-balance sheet deals and
engaging in other tactics to inflate earnings -- customers (as well as
investors and partners) lost confidence in the company. And Enron came
tumbling down.
Furthermore, advantages conferred by superior
technology and information-gathering are fleeting. Competitors learn and
mimic and catch up. Barriers to market entry evaporate. Profit margins
narrow.
Enron, short of incessant innovation, could never
hope to corner Internet market-making, especially in industries, like
telecommunications and paper, that it didn't really understand. In its core
energy market, perhaps Enron was too quick to eschew refineries and
pipelines for the volatile, information-based business of trading.
But it wasn't Internet that killed the beast; it
was management's insatiable appetite for expansion and, by all accounts,
personal enrichment.
It's too easy to kick Enron now that it's down. It
did a lot right. The competition and deregulation and vertical
"de-integration" Enron drove are the future of all industries,
even energy. Enron was making markets on the Internet well before its
competitors knew what hit them.
Was Enron on to a better business model? You bet it
was. But like any business model, it wasn't impervious to rules of conduct
and principles of economics.
Enron's Former CEO Walks Away With $150 Million
One of the really sad part of the Enron scandal is that the thousands of
Enron employees were not allowed to sell Enron shares in their pension funds
and were left hold empty pension funds. One elderly Enron employee on
television last evening lamented that his pension of over $2 million was
reduced to less than $10,000.
But such is not the case for top executives. According to Newsweek
Magazine, December 10, 2001 on Page 6, "Enron chief and Bush buddy
grabs $150 million while employees lose their shirts. Probe him."
A
Message from the Managing partner and CEO of Andersen
"Enron: A Wake-Up Call," by Joe Berardino
The Wall Street Journal,
December 4, 2001, Page A18 http://interactive.wsj.com/archive/retrieve.cgi?id=SB1007430606576970600.djm&template=pasted-2001-12-04.tmpl
A year ago, Enron was one of the world's most admired
companies, with a market capitalization of $80 billion. Today, it's in
bankruptcy.
Sophisticated institutions were the primary buyers of
Enron stock. But the collapse of Enron is not simply a financial story of
interest to major institutions and the news media. Behind every mutual or
pension fund are retirees living on nest eggs, parents putting kids through
college, and others depending on our capital markets and the system of checks
and balances that makes them work.
Our Responsibilities
My firm is Enron's auditor. We take seriously our
responsibilities as participants in this capital-markets system; in
particular, our role as auditors of year-end financial statements presented by
management. We invest hundreds of millions of dollars each year to improve our
audit capabilities, train our people and enhance quality.
When a client fails, we study what happened, from top
to bottom, to learn important lessons and do better. We are doing that with
Enron. We are cooperating fully with investigations into Enron. If we have
made mistakes, we will acknowledge them. If we need to make changes, we will.
We are very clear about our responsibilities. What we do is important. So is
getting it right.
Enron has admitted that it made some bad investments,
was over-leveraged, and authorized dealings that undermined the confidence of
investors, credit-rating agencies, and trading counter-parties. Enron's
trading business and its revenue streams collapsed, leading to bankruptcy.
If lessons are to be learned from Enron, a range of
broader issues need to be addressed. Among them:
Rethinking some of our accounting standards. Like the
tax code, our accounting rules and literature have grown in volume and
complexity as we have attempted to turn an art into a science. In the process,
we have fostered a technical, legalistic mindset that is sometimes more
concerned with the form rather than the substance of what is reported.
Enron provides a good example of how such orthodoxy
can make it harder for investors to appreciate what's going on in a business.
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; certainly more information than disclosure alone could ever provide.
The profession has been debating how to account for
SPEs for many years. It's
time to rethink the rules.
Modernizing our broken financial-reporting model.
Enron's collapse, like the dot-com meltdown, is a reminder that our
financial-reporting model -- with its emphasis on historical information and a
single earnings-per-share number -- is out of date and unresponsive to today's
new business models, complex financial structures, and associated business
risks. Enron disclosed reams of information, including an eight-page
Management's Discussion & Analysis and 16 pages of footnotes in its 2000
annual report. Some analysts studied these, sold short and made profits. But
other sophisticated analysts and fund managers have said that, although they
were confused, they bought and lost money.
We need to fix this problem. We can't long maintain
trust in our capital markets with a financial-reporting system that delivers
volumes of complex information about what happened in the past, but leaves
some investors with limited understanding of what's happening at the present
and what is likely to occur in the future.
The current financial-reporting system was created in
the 1930s for the industrial age. That was a time when assets were tangible
and investors were sophisticated and few. There were no derivatives. No
structured off-balance-sheet financings. No instant stock quotes or mutual
funds. No First Call estimates. And no Lou Dobbs or CNBC.
We need to move quickly but carefully to a more
dynamic and richer reporting model. Disclosure needs to be continuous, not
periodic, to reflect today's 24/7 capital markets. We need to provide several
streams of relevant information. We need to expand the number of key
performance indicators, beyond earnings per share, to present the information
investors really need to understand a company's business model and its
business risks, financial structure and operating performance.
Reforming our patchwork regulatory environment. An
alphabet soup of institutions -- from the AICPA (American Institute of
Certified Public Accountants) to the SEC and the ASB (Auditing Standards
Board), EITF (Emerging Issues Task Force) and FASB (Financial Accounting
Standards Board) to the POB (Public Oversight Board) -- all have important
roles in our profession's regulatory framework. They are all made up of smart,
diligent, well-intentioned people. But the system is not keeping up with the
issues raised by today's complex financial issues. Standard-setting is too
slow. Responsibility for administering discipline is too diffuse and
punishment is not sufficiently certain to promote confidence in the
profession. All of us must focus on ways to improve the system. Agencies need
more resources and experts. Processes need to be redesigned. The accounting
profession needs to acknowledge concerns about our system of discipline and
peer review, and address them. Some criticisms are off the mark, but some are
well deserved. For our part, we intend to work constructively with the SEC,
Congress, the accounting profession and others to make the changes needed to
put these concerns to rest.
Improving accountability across our capital system.
Unfortunately, we have witnessed much of this before. Two years ago, scores of
New Economy companies soared to irrational values then collapsed in dust as
investors came to question their business models and prospects. The dot-com
bubble cost investors trillions. It's time to get serious about the lessons it
taught us. Market Integrity
In particular, we need to consider the
responsibilities and accountability of all players in the system as we review
what happened at Enron and the broader issues it raises. Millions of
individuals now depend in large measure on the integrity and stability of our
capital markets for personal wealth and security.
Of course, investors look to management, directors
and accountants. But they also count on investment bankers to structure
financial deals in the best interest of the company and its shareholders. They
trust analysts who recommend stocks and fund managers who buy on their behalf
to do their homework -- and walk away from companies they don't understand.
They count on bankers and credit agencies to dig deep. For our system to work
in today's complex economy, these checks and balances must function properly.
Enron reminds us that the system can and must be
improved. We are prepared to do our part.
February 2002 Updates
Energy and Commerce and Financial Services Committees continue their
investigation into Enron's finances with testimony from William Powers, Jr.,
Chair of the Special Investigation Committee of the Board of Directors of
Enron, SEC Chairman Harvey Pitt and Joe Berardino, Andersen CEO. You can
access transcripts from the Financial Services Committee at http://www.house.gov/financialservices/testoc2.htm
, and the Energy and Commerce Committee at http://energycommerce.house.gov/
Denny Beresford called my attention to the following
interview. I found it interesting how Joe Berardino got vague when asked for
specifics on "specific changes" that Andersen will call for in the
future. My reactions are still the same in my commentary below.
"Andersen's CEO:
Auditing Needs "Some Changes" Joseph Berardino harbors no doubts
that Enron's fall means his firm's 'reputation is on the line'," Business
Week, December 14, 2001 --- http://www.businessweek.com/bwdaily/dnflash/dec2001/nf20011214_7752.htm
The following is only a
short excerpt from the entire interview with Questions being asked by Business
Week and Answers being provided by Joe Berardino, CEO of Andersen (the
firm that audits Enron).
Q:
If we can go beyond the immediate issues: What changes should this lead to in
the practice of accounting?
A:
That's hell of a good question. And we're giving that a lot of thought. As I
look at this, there needs to be some changes, no question. The marketplace has
taken a severe psychological blow, not to mention the financial blow. I think
as a profession, we have taken a hit.
And so I think we're prepared to think very boldly about change. I'd suggest
to you that I've got two factors that I will consider in suggesting or
accepting change. No. 1: Will this change -- whatever it might be --
significantly help us in improving the public's perception and trust in our
profession? Secondly, will it really make a difference in terms of helping us
improve our practice? And I'd also suggest that the capital market needs to
look at itself and say whether or not everything performed as well as it could
have.
Q: I don't quite understand what specific change you'd like to see. Some
people have said the auditing ought to be much more tightly regulated, somehow
divorced from the firms...that the government ought to handle or oversee it.
And consulting and auditing certainly ought to be separated. Do you think such
dramatic changes are necessary?
A: I hear the same things, too.... As each day goes on, we all are
learning something new. And people are having a broader perspective on what
happened. And I'm not saying this should take forever, but let's give us a
little more time to stand back...before we rush to solve the problems of the
world.
Q: May I ask one quick question specific to Enron? Where does the fault
here lie -- with you, with them, with the press, the marketplace?
A: I think we're all in the fact-gathering stage, and the thing that I've
been encouraged by, walking around Capitol Hill today, is our lawmakers are in
a fact-gathering stage. Let's just let this play out a little bit.
Arthur
Andersen LLP had one organizational policy that, more than any other single
factor, probably led to the implosion of the firm? What was that policy
and how did it differ from the other major international accounting
firms?
April 3, 2002 message from Dennis Beresford [dberesfo@TERRY.UGA.EDU]
One of the things that I find most fascinating about
the Enron/Andersen saga is how much inside information is being made public
(thanks to our electronic age). Yesterday the House Energy and Commerce
Committee released a series of internal Andersen memos showing the dialogue
between the executive office accounting experts and the Houston office client
service people. While I haven't had a chance to read all 94 pages yet, the
memos are reported to show that the executive office experts raised
significant questions about Enron's accounting. But the Houston people were
able to ignore that advice because Andersen's internal policies required the
engagement people to consult but not necessarily to follow the advice they
received. As far as I know, all other major accounting firms would require
that consultation advice be followed.
You can view and download the 94 pages at: http://energycommerce.house.gov/107/news/04022002_527.htm#docs
Denny Beresford
Concerning the Self-Regulation Record of State Boards of Accountancy:
Don't Kick Them Really Hard Until They Are Already Dying
Andersen's failure to comply with professional
standards was not the result of the actions on one 'rogue' partner or
'out-of-control' office, but resulted from Andersen's organizational structure
and corporate climate that created a lack of independence, integrity and
objectivity.
Texas State Board of Public Accountancy, May 24, 2002
"Texas Acts to Punish Arthur Andersen," San Antonio Express News,
May 24, 2002, Page 1.
At the time of this news article, the Texas State Board announced that it was
recommending revoking Arthur Andersen LLP's accounitn license in Texas and
seeking $1,000,000 in fines and penalties.
Bob Jensen's threads on the Enron/Andersen scandals are at http://www.trinity.edu/rjensen/fraud.htm
|
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.
Enron Former Executive Pleads Guilty to Conspiracy
The guilty plea in Houston federal court yesterday
by Christopher Calger, a 39-year-old former vice president in Enron's North
American unit, involved a 2000 transaction known as Coyote Springs II in
which the company sold some energy assets, including a turbine, to another
company. In his guilty plea, Mr. Calger said that he and "others engaged in
a scheme to recognize earnings prematurely and improperly" with the help of
a private partnership, known as LJM2 that was run and partly owned by
Enron's then-chief financial officer, Andrew Fastow. To avoid problems with
Enron's outside auditors, company officials were "improperly hiding LJM2's
participation in this transaction," according to Mr. Calger's plea.
John Emshjwiller, "Enron Former Executive Pleads Guilty to Conspiracy,"
The Wall Street Journal, July 15, 2005; Page B2 ---
http://online.wsj.com/article/0,,SB112139210586786521,00.html?mod=todays_us_marketplace
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.
-
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!
-
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.
You can download the passage below from
http://www.trinity.edu/rjensen/FraudSpacek01.htm
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
|
Ernst
& Young changes its mind
|
|
Firm
reported to reverse its stance on how companies account for stock
options.
February
14, 2003
:
6:26 AM EST
|
|
NEW YORK
(Reuters) -
Accounting firm Ernst & Young has reversed its opinion on how
companies should account for stock options, saying financial statements
should reflect their bottom-line cost, the New York Times
reported Friday.
The firm, which is
under fire for advising executives at Sprint
(FON:
Research,
Estimates)
to set up tax shelters related to their stock option transactions, made
its change of heart public in a letter to the Financial Accounting
Standards Board (FASB), the article said.
Ernst & Young, along with other major accounting groups, maintained
for years that options should not be deducted as a cost to the companies
that grant them, but the Times reported that now the firm says
options should be reflected as an expense in financial statements.
The FASB, which
makes the rules for the accounting profession, and the International
Accounting Standards Board, its international counterpart, are trying to
develop standards that are compatible for domestic and international
companies.
In its letter,
Ernst & Young said it strongly supported efforts by both groups to
develop a method to ensure that "stock-based compensation is
reflected in the financial statements of issuing enterprises," the
report said. The firm expressed reservations about methods that might be
used to value options, but it noted that the current environment
requires that the accounting for options provide relevant information to
investors.
The letter had been in the works for some time and was
unrelated to the recent events surrounding its advice to the Sprint
executives, Beth Brooke, global vice chairwoman at Ernst & Young,
told the Times.
|
"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].
[28] STATEMENT FROM BIG FIVE CEOS ON ENRON The
following is being issued jointly by Andersen, KPMG, Deloitte & Touche,
PricewaterhouseCoopers and Ernst & Young. We have reported the statement
verbatim: As with other business failures, the collapse of Enron has drawn
attention to the accounting profession, our role in America's financial
markets and our public responsibilities. We recognize that a strong, diligent,
and effective profession is a critically important component of the financial
reporting system and fundamental to maintaining investor confidence in our
capital markets. We take our responsibility seriously. [Click through to http://accountingeducation.com/news/news2362.html
for the balance of the statement] [AP].
[29] ENRON AND ARTHUR ANDERSON UNDER THE LOOKING
GLASS All eyes are on Enron these days, as the Company has filed for
bankruptcy protection, the largest such case in the U.S. The Enron collapse
has the whole accounting and auditing industry astir. The lack of confidence
in Enron by investors was the result of several factors, including inadequate
disclosure for related-party transactions, financial misstatements and massive
off-balance-sheet liabilities. Whilst this issue has been extensively covered
in the Press, we provide a brief summary of the story in our full item at http://accountingeducation.com/news/news2355.html
. More details will follow on this important issue as it continues to unfold
[FD].
Betting the Farm: Where's the Crime?
The story is as old as history of mankind. A farmer has two
choices. The first is to squeeze out a living by tilling the soil,
praying for rain, and harvesting enough to raise a family at a modest rate of
return on capital and labor. The second is to go to the saloon and bet
the farm on what seems to be a high odds poker hand such as a full house or
four deuces.
When CEO Ken Lay says that the imploding of Enron was due to an economic
downturn and collapse of energy prices, he is telling it like it is. He
and his fellow executives Jeff Skilling and Andy Fastow did indeed begin to
bet the farm six years ago on a relatively sure thing that energy prices would
rise. They weren't betting the farm (Enron) on a literal poker hand, but
their speculations in derivative financial instruments were tantamount to
betting on a full house or four deuces. And as their annual bets went
sour, they borrowed to cover their losses and bet the borrowed money in
increasingly large-stake hands in derivative financial instruments.
Derivative financial instruments are two-edged swords. When used
conservatively, they can be used to eliminate certain types of risk such
as when a forward contract, futures contract, or swap is used to lock in a
future price or interest rate such that there is no risk from future market
volatility. Derivatives can also be used to change risk such as when a
bond having no cash flow risk and value risk is hedged so that it has no value
risk at the expense of creating cash flow risk. But if there is no
hedged item when a derivative is entered into, it becomes a speculation
tantamount to betting the farm on a poker hand. The only derivative that
does not have virtually unlimited risk is a purchased option. Contracts
in forwards, futures, swaps (which are really portfolio of forwards), and
written options have unlimited risks unless they are hedges.
Probably the most enormous example of betting on derivatives is the
imploding of a company called Long-Term Capital (LTC). LTC was formed by
two Nobel Prize winning economists (Merton and Scholes) and their
exceptionally bright former doctoral students. The ingenious arbitrage
scheme of LTC was almost a sure thing, like betting on four deuces in a poker
game having no wild cards. But when holding four deuces, there is a
miniscule probability that the hand will be a loser. The one thing that
could bring LTC's bet down was the collapse of Asian markets, that horrid
outcome that eventually did transpire. LTC was such a huge farm that its
gambling losses would have imploded the entire world's securities marketing
system, Wall Street included. The world's leading securities firms put
up billions to bail out LTC, not because they wanted to save LTC but because
they wanted to save themselves. You can read about LTC and the other
famous derivative financial instruments scandals at http://www.trinity.edu/rjensen/fraud.htm#DerivativesFraud
There is a tremendous (one of the
best videos I've ever seen on the Black-Scholes Model) PBS Nova video
explaining why LTC collapsed. Go to http://www.pbs.org/wgbh/nova/stockmarket/
Given Enron's belated restatement of reported high earnings since 1995 into
huge reported losses, it appears that Enron was covering its losses with
borrowed money that its executives threw back into increasingly larger
gambles that eventually put the entire farm (all of Enron) at risk. As
one reporter stated in a baseball metaphor, "Enron was swinging for the
fences."
Whether or not top executives of a firm should be allowed to bet the farm
is open to question. Since Orange County declared bankruptcy after
losing over $1 billion in derivatives speculations, most corporations have
written policies that forbid executives from speculating in derivatives.
Enron's Board of Directors purportedly (according to Enron news releases) knew
the farm was on the line in derivatives speculations and did not prevent
Skilling, Fastow, and Lay from putting the entire firm in the pot.
So where's the crime?
The crime lies in deceiving employees, shareholders, and investors and
hiding the relatively small probability of losing the farm by betting on what
appeared to be a great hand. The crime lies in Enron executives'
siphoning millions from the bets into their pockets along the way while
playing a high stakes game with money put up by creditors, investors, and
employees.
The crime lies is accounting rules that allow deception and hiding of risk
through such things as special
purpose entities (SPEs) that allow management to keep debt off balance
sheets, thereby concealing risk. The crime lies at the foot of an
auditing firm, Andersen, that most certainly knew that the farm was in the
high-stakes pot but did little if anything to inform the public about the high
stakes game that was being played with the Enron farm in the pot.
Andersen contends that it played by each letter of the law, but it failed to
let on that the letters spelled THE FARM IS IN THE POT AT ENRON! The
crime lies in having an audit committee that either did not ask the right
questions or went along with the overall deception of the public.
So who should pay?
I hesitate to answer that, but I really like the analysis in three articles
by Mark Cheffers that Linda Kidwell pointed out to me. These are
outstanding assessments of the legal situation at this point in time.
I have greatly updated my threads on
this, including an entire section on the history of derivatives fraud in the
world. Go to http://www.trinity.edu/rjensen/fraud.htm
Note especially the following link to Mark Cheffers' articles at
--- http://www.accountingmalpractice.com.
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
Bob Jensen's threads on derivative financial instruments are
at http://www.trinity.edu/rjensen/caseans/000index.htm
NASA
[The General Accounting Office] said the Arthur
Andersen audits were audit failures," says Gregory Kutz. "They
had given NASA clean audit opinions for five years."
PricewaterhouseCoopers, the agency's auditor, issued
a disclaimed opinion on NASA's 2003 financial statements. PwC complained that
NASA couldn't adequately document more than $565 billion — billion — in
year-end adjustments to the financial-statement accounts, which NASA delivered
to the auditors two months late. Because of "the lack of a sufficient audit
trail to support that its financial statements are presented fairly,"
concluded the auditors, "it was not possible to complete further audit
procedures on NASA's September 30, 2003, financial statements within the
reporting deadline established by [the Office of Management and Budget]."
"NASA, We Have a Problem," by Kris Frieswick, CFO Magazine,
May 2004, pp.54-64 --- http://www.cfo.com/article/1,5309,13502,00.html?f=home_magazine
Can Gwendolyn Brown fix the space agency's chronic
financial woes?
The National Aeronautics and Space Administration
has long been criticized for its inability to manage costs. During the
1990s, faced with flat budgets and ambitious program goals, NASA adopted a
management approach of "faster, better, cheaper." But by the
decade's end, the approach was blamed for a number of mission failures.
Meanwhile, the cost of the International Space Station (ISS) spiraled
billions of dollars over budget. Embattled administrator Daniel Goldin
resigned in 2001 after nearly 10 years on the job, and NASA named Sean
O'Keefe, a self-described "bean counter," as Goldin's replacement.
Fourteen months later, the loss of the Columbia space shuttle and its seven
astronauts shook the agency to its core.
Then, last January, President George W. Bush
unveiled a grand "vision" of landing astronauts on the moon by
2020, and on Mars sometime thereafter. The vision gave NASA a new sense of
mission, lifted its morale, and raised expectations of steadily increasing
budgets. But the vision also came under fire from critics who wondered fire
from critics who wondered why the country needed to go to Mars, and how it
could afford it.
Two weeks later, troubling new doubts were raised
about NASA's financial management. PricewaterhouseCoopers, the agency's
auditor, issued a disclaimed opinion on NASA's 2003 financial statements.
PwC complained that NASA couldn't adequately document more than $565 billion
— billion — in year-end adjustments to the financial-statement
accounts, which NASA delivered to the auditors two months late. Because of
"the lack of a sufficient audit trail to support that its financial
statements are presented fairly," concluded the auditors, "it was
not possible to complete further audit procedures on NASA's September 30,
2003, financial statements within the reporting deadline established by [the
Office of Management and Budget]."
Ironically, the PwC audit report was posted on the
NASA inspector general's Website on March 11 — the same day that O'Keefe
testified before a Senate appropriations subcommittee regarding the agency's
FY 2005 budget request. But no one seemed to notice, or care.
NASA says blame for the financial mayhem falls
squarely on the so-called Integrated Financial Management Program (IFMP), an
ambitious enterprise-software implementation. In June 2003, the agency
finished rolling out the core financial module of the program's SAP R/3
system. NASA's CFO, Gwendolyn Brown, says the conversion to the new system
caused the problems with the audit. In particular, she blames the difficulty
the agency had converting the historical financial data from 10 legacy
systems — some written in COBOL — into the new system, and reconciling
the two versions for its year-end reports. Brown says that despite the
difficulties with both the June 30 quarterly financial-statement preparation
and the year-end close, the system is up and running, and she has confidence
in the accuracy of the agency's financial reporting going forward.
Continued in the article (this is a very long article)
Worldcom Fraud
The Worldcom/Andersen Scandal
KPMG’s “Unusual Twist”
While KPMG's strategy isn't uncommon among corporations with lots of units in
different states, the accounting firm offered an unusual twist: Under KPMG's
direction, Worldcom treated "foresight of top management" as an intangible asset
akin to patents or trademarks.
This "foresight of
top management" led to a 25-year prison sentence for Worldcom's CEO,
five years for the CFO (which in his case was much to lenient) and one
year plus a day for the controller (who ended up having to be in prison
for only ten months.) Yes all that reported goodwill in the balance
sheet of Worldcom was an unusual twist.
The
Worldcom fraud accompanied by one of the largest bankruptcies is characterized
by what, in my viewpoint, was the worst audit in the history of the world that
contributed, along with Enron, to the implosion of the historic Arthur Andersen
accounting firm.
June
15, 2009 message from Dennis Beresford
[dberesfo@TERRY.UGA.EDU]
I apologize
if this is something that has already been mentioned but I just became
aware of a very interesting video of former Worldcom Controller David
Meyers at Baylor University last March -
http://www.baylortv.com/streaming/001496/300kbps_str.asx
The first 20
minutes is his presentation, which is pretty good - but the last 45
minutes or so of Q&A is the best part. It is something that would be
very worthwhile to show to almost any auditing or similar class as a
warning to those about to enter the accounting profession.
Denny Beresford
Jensen Comment on Some Things You Can Learn
from the Video
David Meyers became a convicted felon largely because he did not say no when
his supervisor (Scott Sullivan, CFO) asked him to commit illegal and
fraudulent accounting entries that he, Meyers, knew was wrong.
Interestingly, Andersen actually lost the audit midstream to KPMG, but KPMG
hired the same audit team that had been working on the audit while employed
by Andersen. David Myers still feels great guilt over how much he hurt
investors. The implication is that these auditors were careless in a very
sloppy audit but were duped by Worldcom executives rather than be an actual
part of the fraud. In my opinion, however, that the carelessness was beyond
the pale --- this was really, really, really bad auditing and accounting.
At the time he did wrong, he rationalized
that he was doing good by shielding Worldcom from bankruptcy and protecting
employees, shareholders, and creditors. However, what he and other criminals
at Worldcom did was eventually make matters worse. He did not anticipate
this, however, when he was covering up the accounting fraud. He could've
spent 65 years in prison, but eventually only served ten months in prison
because he cooperated in convicting his bosses. In fact, all he did after
the fact is tell the truth to prosecutors. His CEO, Bernard Ebbers, got 25
years and is still in prison.
The audit team while with Andersen and KPMG
relied too much on analytical review and too little on substantive testing
and did not detect basic accounting errors from Auditing 101 (largely
regarding capitalization of over $1 billion expenses that under any
reasonable test should have been expensed).
Meyers feels that if
Sarbanes-Oxley had been in place it may have deterred the fraud. It also
would've greatly increased the audit revenues so that Andersen/KPMG could've
done a better job.
To Meyers credit, he did not exercise his
$17 million in stock options because he felt that he should not personally
benefit from the fraud that he was a part of while it was taking place.
However, he did participate in the fraud to keep his job (and salary). He
also felt compelled to follow orders the CFO that he knew was wrong.
The hero is detecting the fraud was internal
auditor Cynthia Cooper who subsequently wrote the book:
Extraordinary Circumstances: The Journey of a Corporate
Whistleblower (Hoboken, New Jersey: John Wiley & Sons, Inc.. ISBN
978-0-470-12429)
http://www.amazon.com/gp/reader/0470124296/ref=sib_dp_pt#
Meyers does note that the whistleblower, Cooper, is now a hero to the
world, but when she blew the whistle she was despised by virtually everybody
at Worldcom. This is a price often paid by whistleblowers ---
http://www.trinity.edu/rjensen/FraudConclusion.htm#WhistleBlowing
2008 Update on Worldcom Fraud (and a bit of history)
"SEC Settlement with Auditors of
Worldcom: Too Little, Too Late?" by Tom
Selling, The Accounting Onion, April 21, 2008 ---
http://accountingonion.typepad.com/theaccountingonion/2008/04/sec-settles-wit.html
Coming on the heels of accusations that the SEC
is trending toward less vigorous enforcement against financial reporting
violations, the SEC published here and here its settlements with the two
Arthur Andersen partners that planned and supervised the 2001 audit of
Worldcom. Six years later, the settlements amount to little more than
slaps on the wrist: both auditors were suspended from practicing before
the SEC for at least three years, no monetary penalties were assessed,
and no admissions of guilt were obtained. (By the way, one of the
auditors has let his CPA license lapse, and the other is still licensed
as a CPA in Mississippi.)
I have three questions for the SEC. First, why
were these individuals allowed to settle without admitting or denying
guilt in what appears to have been an open-and-shut case? Second, why
were no monetary penalties assessed? Third, why did it take six years,
with only this so-called "settlement" to show for all this time and,
presumably, effort?
I'll leave any kind of thorough treatment of
the last two questions for future ruminations (feel free to do it
without me!), and will focus henceforth on my dissatisfaction with a
settlement that does not require auditors to admit to the public that
they made inexcusable mistakes -- in what was apparently a slam-dunk
case.
Background
Most readers will recall that the
Worldcom
accounting fraud was astonishing for both the magnitude of the errors in
the financial statements, and the simplicity of the accounting. We're
not talkin' 'bout complex financial arrangements, arcane consolidation,
pension, stock option or revenue recognition rules; we're talkin' the
third week of Accounting 101. We're talkin' about capitalizing telephone
line access fees ("line costs") that should have been expensed. Over a
number of quarters, $3 billion in payments that should have been
reported as expenses on the income statement were parked in property and
equipment (P&E) accounts on the balance sheet. The "top-side" accounting
entries to effectuate the fraudulent misstatements circumvented internal
controls and were made by accountants with the highest authority in the
company.
The $3 billion capitalization of line costs was
the first of the Worldcom accounting frauds to come to light, but it
paled in comparison to the additional $8 billion of accounting
misstatements that were subsequently discovered. As Cynthia Cooper, the
whistle blower on the first $3 billion wrote in her recent book (I
reviewed it here):
"...[top management at
Worldcom] had a process
called 'close the gap,' whereby they would compare quarterly revenue to
Wall Street expectations, analyze potential items they could record to
make up the difference, and book revenue items that had not been booked
in the past."
Given the magnitude of the misstatements, it
doesn't seem possible that they could have occurred in the absence of a
broken audit. The two Andersen partners on the Worldcom account were
charged with violating the SEC's own rules of professional conduct as
they apply to accountants* who practice before the Commission: Rule
102(e). That also should have kept things relatively simple, as the case
would be made before an administrative law judge; no interaction with
the courts or other government agencies would have been required. I'm
not a lawyer, but I think that the threshold standard of proof in such a
case would have been the same as civil litigation, "preponderance of
evidence."
Also, the SEC reached only for the low-hanging
fruit when bringing their charges against the two audit partners, both
of whom had been involved with Worldcom for a number of years.
Basically, in addition to intentional, knowing or reckless conduct, the
most difficult to prove, there are two other ways that an accountant can
violate Rule 102(e):
A single instance of highly unreasonable
conduct that results in a violation of professional standards in
circumstances in which the accountant should know that heightened
scrutiny is warranted, or; Repeated instances of (merely) unreasonable
conduct, each resulting in a violation of professional standards, that
indicate a lack of competence. The SEC wisely chose the second of these
two. All they wanted, and needed, to address was conduct in violation of
the equivalent of the third week of Accounting 101 plus the third or
fourth week of Auditing 101. At the risk of being tedious, but to
educate my readers who are taking Auditing 101 and to make the point
that the SEC must have had a slam-dunk case, here is but a sample of the
SEC's allegations:
Andersen discovered fraud of a similar nature a
year earlier, and affecting the same PP&E accounts. There were other
strong indicators that fraud might occur, like the financial straits of
the CEO, a history of aggressive accounting, and industry factors.
Consequently, the engagement team classified overall audit risk as
"maximum." However, substantive tests of PP&E , one of the most
significant balance sheet categories, were not expanded. The auditor's
did not design or implement procedures to review top-side entries,
evidently relying on management's representation that there were no
significant top-side entries--even though fraud via top-side entries
took place just one year earlier. Additions to the PP&E accounts were
only examined through the third quarter of 2001, and not as of the end
of the fiscal year. $841 million of the fraudulent charges to PP&E
occurred in the fourth quarter. A reconciliation of beginning and ending
PP&E balances was not done. If the auditors had done so, they would have
discovered that the $3 billion in fraudulent charges to PP&E were made
in circumvention of normal approval processes. The expense accounts that
were reduced by the top side entries were not reconciled to the
financial statements and general ledger. "Had they done so, the auditors
would have discovered that the line cost expenses they were testing were
significantly larger than the line cost expenses reflected in Worldcom's
financial statements and general ledger." Back to the Question
Let's be generous, and presume that those who
pull the levers at the SEC subjugate their personal interests for the
public interest. Indeed, one could argue that there have been many cases
where the SEC obtained the same monetary fines and sanctions -- or maybe
even more -- in a settled action than it could have gotten in court. One
of the reasons this may be the case is that many defendants have an
economic disincentive to admit guilt in an SEC action. That's because
(once again, I'm not a lawyer) one who admits guilt to the government
may not deny it in a private action -- where the money penalties could
be much bigger.
So, in many instances, it may actually serve
the public interest to give defendants the option of settlement with the
SEC without an admission of guilt; but, my point is that it is certainly
not always the case. Now, ceasing to presume motives as pure as the
driven snow, the SEC counts scalps, and a settlement containing an
agreement to be sanctioned, however meaningless, counts as a scalp to be
hung up in their reports to Congress. Fewer settlements means more
trials, and more trials means fewer scalps. Even considering the
predispositon for scalps of any color, this case took six years just to
get settled! And, how many defendants are coerced into settling without
admitting or denying guilt just so the SEC can have their scalp, even
though they truly feel they did nothing wrong, but need to get the
matter put behind them?
Focusing specifically on the case of the
Worldcom auditors, I can't possibly see how the public interest was
served by settling without a fine, and without an admission of guilt. If
there was ever a case where the SEC could have sent an unequivocal
message by making its case in court, this one was it. Can anyone say
that more was gained by settling? Given the magnitude of the numbers,
timing and other circumstances, can anyone say that the the public does
not rightfully want to know whether and how Worldcom's auditors violated
the basic standards of their profession?
And, not only is there a message opportunity,
the public deserves more justice and closure. Will private litigation
against these auditors take place? I doubt it, because their pockets
probably aren't deep enough to fund the private attorneys. Therefore,
the argument of a defendant loathe to settle because of exposure to
private litigation goes poof. Will the AICPA or state accountancy boards
discipline these auditors? It's been six years, and so far not a peep
from them either -- just one more reason we need the PCAOB.
For the SEC, it shouldn't be about the money
they collect in fines, or the number of years of sanctions they obtain
from settlement, or even (and this is, I admit, controversial) about the
sheer number of cases they bring. It should be about deterrence: the
message sent by a case that will contribute to greater trust in the
capital markets by reducing the risk of fraud. The reality, though, is
that it is very convenient and self-serving to measure monetary fines,**
volume of cases and years barred from practicing before the Commission.
The flip side of this reality is that one cannot possibly measure how
many frauds did not occur because of the threat of vigorous and
consequential law enforcement. Ergo, the focus of bureaucrats on the the
scalps; in the case of the 2001 Worldcom audit in results in giving
unduly short shrift to deterrence.
-----------
*Note to students: the SEC rules of professional conduct apply to all
accountants at public companies -- not just their auditors.
**Well, maybe you can't always measure the
effectiveness of the SEC by the fines they mete out. See Jonathan Weil's
commentary in bloomberg.com on how he believes SEC Chair Cox inflated
the numbers he reported in recent congressional testimony.
2006 Update on Worldcom Fraud
U.S. Judge Denise Cote of the U.S. Court for the Southern District of New
York said the distribution should be made "as soon as practicable." More
than one dozen investment banks, including Citigroup Inc. and JPMorgan Chase
& Co., agreed to pay about $6.15 billion to resolve allegations that they
helped Worldcom sell bonds when they should have known the phone company was
concealing its true financial condition. The remaining balance from
available settlement funds will continue to accrue interest until other
claims are processed and disputed claims are resolved, Cote said in her
four-page order.
"Judge OKs $4.52 bln payout to Worldcom investors," Reuters, November
29, 2006 ---
Click Here
Worldcom's head of internal auditing blew the whistle on the accounting
fraud (over $1 billion) by the highest Worldcom executives and the worst Big
Five accounting firm audit in the history of the world. She's now viewed as the
"Mother of Sarbanes-Oxley Section 404."
Recent Interview
In February 2008, CFO Magazine did an article about her and her new book:
"Worldcom Whistle-blower Cynthia Cooper: What she was feeling and thinking
as she took the steps that, as it turned out, would change Corporate
America," by . David M. Katz and Julia Homer, CFO Magazine, February
1, 2008, pp. 38-40.
Blowing the Whistle on Cynthia Cooper (the Worldcom scandal's main
whistleblower) in a critical review of her book
Extraordinary Circumstances
by Cynthia Cooper, former Internal Auditor of Worldcom
Barnes and Noble ---
http://search.barnesandnoble.com/booksearch/isbnInquiry.asp?z=y&EAN=9780470124291&itm=2
Publisher: Wiley, John & Sons, Incorporated Pub. Date: February 2008 ISBN-13:
9780470124291 Sales Rank: 27,246
""Extraordinary Circumstances": Take it to the Beach ," by Tom Selling,
The Accounting Onion, February 7, 2008 ---
http://accountingonion.typepad.com/
I decided to read "Extraordinary Circumstances"
because I wanted to learn more about the major players at Worldcom, how
the fraud was discovered, and how it was perpetrated. I was also curious
to learn how the story of a fraud that was so simple at its core could
take more than 350 pages to tell.
As it turns out, the story I was expecting
could have easily been told in about one hundred pages; even the chapter
titles indicated that it would take me at least 200 pages to get where I
thought I actually wanted to begin. But, as I was reading the book,
impatient to get to the good stuff, I got hooked on the seeming
mundaneness of how a smart but not brilliant, hardworking but not
obsessed teenager, got hired and fired, married and divorced, have
children, and marry again to a stay-at-home Dad. Much of this was
skillfully interwoven with the history of Worldcom, along with the
pathos of good corporate soldier accountants meeting their end, and the
tragedy of the demigods of the telecommunications industry going to any
extreme to avoid experiencing the consequences of their own fallibility.
Continued in article
Jensen Comment
After reading Tom's full critical review I have the feeling that when he says
"Take it to the Beach" he means throw it as far as possible into the water.
Cynthia spoke at a plenary session a few years ago at an American Accounting
Association annual meeting. I don't think the AAA got its money's worth that
day. She seems to be exploiting this sad event year after year for her own
personal gain as well as an ego trip.
Bob Jensen's threads on the Worldcom fraud (read that the worst audit in
the history of the world by a major international auditing firm) are at
http://www.trinity.edu/rjensen/FraudEnron.htm#WorldcomFraud
February 8, 2008 reply from Dennis Beresford
dberesfo@uga.edu
Bob, For a slightly different perspective, I bought
copies for each of my MAcc students and gave the books to them this week.
I'm not requiring the students to read the book but I told them it would be
a good idea to do so. As Tom indicates, this is not a complete analysis of
Worldcom's accounting. Interested parties can get that from the report of
the special board committee that investigated the Worldcom fraud. That
report is available through the company's filings in the SEC Edgar system.
What the book is, however, is a highly personal
story of how Cynthia courageously blew the whistle on what became the
world's largest accounting fraud. I've plugged the book to students, audit
committes, and others who can learn from her difficulties and be better
prepared if ever faced with an ethical challenge of their own. There have
been very few true heros of the accounting fiascos of the early 2000's, but
Cynthia is definitely one of them.
Rather than disparaging her efforts to educate
others about her experiences, I think we should all glorify one who clearly
did the right thing at immense cost to her personally.
Denny Beresford
February 8, 2008 reply from Bob Jensen
Hi Denny
My position is that Cynthia Cooper is indeed one of the three most
courageous women that were featured on the cover of Time Magazine in 2002.
I'll forward a second post about those three heroes.
Indeed I agree with Denny that Ms. Cooper is a hero, but that does not
mean we have to praise her book. Efforts to get rich (from speeches and
books) after blowing the whistle push ethics to the edge, some far worse
than these three heroes.
You can read the following among my other whistle blower threads at
http://www.trinity.edu/rjensen/FraudConclusion.htm#WhistleBlowing
"Time Names Whistle-Blowers as
Persons of the Year 2002", Reuters, December 22, 2002 ---
http://www.reuters.com/newsArticle.jhtml?type=topNews&storyID=1948721
Time Magazine named a trio of
women whistle-blowers as its Persons of the Year on Sunday,
praising their roles in unearthing malfeasance that eroded
public confidence in their institutions.
Two of the women, Sherron
Watkins, a vice president at Enron Corp., and Cynthia Cooper of
Worldcom Inc., uncovered massive accounting fraud at their
respective companies, which both went bankrupt.
The third, Coleen Rowley, is
an agent for the Federal Bureau of Investigation. In May, she
wrote a scathing 13-page memo to FBI Director Robert Muller
detailing how supervisors at a Minneapolis, Minnesota field
office brushed aside her requests to investigate Zacarias
Moussaoui, the so-called "20th hijacker" in the Sept. 11th
attacks, weeks before the attacks occurred.
"It came down to did we want
to recognize a phenomenon that helped correct some of the
problems we've had over the last year and celebrate three
ordinary people that did extraordinary things," said Time
managing editor Jim Kelly.
Other people considered by the
magazine, which hits stores on Monday, included President Bush,
al Qaeda leader Osama bin Laden, Vice President Dick Cheney and
New York attorney general Eliot Spitzer.
Bush was seen by some as the
front-runner, especially after he led his party to a mid-term
electoral upset in November that cemented the party's majority
in Congress.
However, Kelly said "some of
(Bush's) own goals: the capture of Osama bin Laden, the
unseating of Saddam Hussein, the revival of a sluggish economy,
haven't happened yet. There was a sense of bigger things to
come, and it might be wise to see how things played out," he
added.
Watkins, 43, is a former
accountant best known for a blunt, prescient 7-page memo to
Enron chairman Kenneth Lay in 2001 that uncovered questionable
accounting and warned that the company could "implode in a wave
of accounting scandals."
Her letter came to light
during a post-mortem inquiry conducted by Congress after the
company declared bankruptcy.
Cooper undertook a one-woman
crusade inside telecommunications behemoth Worldcom, when she
discovered that the company had disguised $3.8 billion in losses
through improper accounting.
When the scandal came to light
in June after the company declared bankruptcy, jittery investors
laid siege to global stock markets.
FBI agent and lawyer Rowley's
secret memo was leaked to the press in May. Weeks before Sept.
11, Rowley suspected Moussaoui might have ties to radical
activities and bin Laden, and she asked supervisors for
clearance to search his computer.
Her letter sharply criticized
the agency's hidebound culture and its decision-makers, and gave
rise to new inquiries over the intelligence-gathering failures
of Sept. 11.
My Foremost Whistle Blower
Hero Who's Heads and Shoulders Above the Time Magazine Trio
Cindy Ossias not only
risked her job, she risked her law license to ever work again as an
attorney. She also blew the whistle at the risk of going to jail.
Unlike the Time Magazine Women of the Year, Cindy Ossias knew
there was no hope in blowing the whistle to her boss. Her boss was
the big crook when she blew the whistle on him and the large home
owner insurance companies operating in the State of California.
http://www.insurancejournal.com/magazines/west/2000/07/10/coverstory/21521.htm
January 6, 2002 message form Hossein Nouri
-----Original Message-----
From: Hossein Nouri
[mailto:hnouri@TCNJ.EDU]
Sent: Monday, January 06, 2003 10:46 AM
To:
AECM@LISTSERV.LOYOLA.EDU
Subject: Re: Time Magazine's Persons of the Year 2002
In the case of Enron, I
remember I read (I think in US News) that the whistle-blower
sold her Enron's shares before speaking out and made a
significant profit. I do not know whether or not she returned
that money to the people who lost their money. But if she did
not, isn't this ethically and morally wrong?
January 6, 2002 reply from Bob Jensen
Hi Hossein,
This is a complex issue. In a sense, she might
have simply taken advantage of insider information for financial
gain. That is unethical and in many instances illegal.
She also may have acted in a manner only to
ensure her own job security --- See "Sherron Watkins Had
Whistle, But Blew It" http://www.forbes.com/2002/02/14/0214watkins.html
That would be unethical.
However, in this particular case, she
allegedly believed that it was not too late to be corrected by
Ken Lay and Andersen auditors. Remember that she did not whistle
blow to the public. Whistle blowers face a huge dilemma between
whistle blowing on the inside versus whistle blowing on the
outside.
Quite possibly (you will say "Yeah sure!")
Watkins really had reasons to sell even if she had not detected
any accounting questions? There are many reasons to sell, such
as a timing need for liquidity and a need to balance a
portfolio.
Somewhat analogous dilemmas arise when
criminals cooperate with law enforcement to gain lighter
punishments. Is it unethical to let a criminal off completely
free because that criminal testifies against a crime figure
higher up the chain of command? There are murderers (one named
Whitey from Boston) who got off free by testifying.
Incidentally, Whitey went on to commit more murders!
PS, I think Time
Magazine failed to make a hero out of the most courageous
whistle blower in recent years. Her name is Cindy Ossias ---
http://www.insurancejournal.com/magazines/west/2000/07/10/coverstory/21521.htm
Cindy Ossias not only
risked her job, she risked her law license to ever work again as
an attorney. She also blew the whistle at the risk of going to
jail. Unlike Sherron Watkins, Cindy Ossias knew there was no
hope in blowing the whistle to her boss. Her boss was the big
crook when she blew the whistle on him and the large home owner
insurance companies operating in the State of California.
Bob Jensen
|
Rick Telberg has a summary review in his CPA Trendlines ---
http://cpatrendlines.com/2008/02/08/extraordinary-circumstances-stirs-debate-in-cpa-circles/
2005 Update on Worldcom Fraud
Former Worldcom Investors can now claim back
some of the billions of dollars they lost in a massive accounting fraud,
after a federal judge approved legal settlements of "historic proportions."
The deal approved Wednesday by U.S. District Judge Denise Cote, will divide
payments of $6.1 billion among approximately 830,000 people and institutions
that held stocks or bonds in the telecommunications company around the time
of its collapse in 2002.
Larry Neumeister, "Judge OKs $6.1B in Worldcom Settlements," The
Washington Post, September 22, 2005 ---
http://snipurl.com/WorldcomSettlement
University of California gets a settlement from Citigroup as part of
its losses in the Worldcom accounting scandal
Citigroup has agreed to pay the University of
California
more than $13 million to settle a lawsuit over
liability for the university’s investments in Worldcom, a company that
collapsed in 2002. The university sued over inaccurate analyses of Worldcom,
which led UC to pay more than it would have otherwise to buy stock in the
company.
Inside Higher Ed, April 7, 2006 ---
http://www.insidehighered.com/news/2006/04/07/qt
Worldcom defendants in $651 million deal
A group of investment banks and other defendants
agreed on Thursday to pay a combined $651 million to a coalition of
institutional investors that lost money in Worldcom Inc.'s collapse. . . .
More than 65 institutional investors are part of the pact, including the
largest U.S. pension fund, the California Public Employees' Retirement
System. Others set to get payments include the California State Teachers'
Retirement System and pension funds in Illinois, Washington state and
Tennessee. The bulk of the settlement will be paid by Worldcom's former
investment banks -- primarily Citigroup and JP Morgan Chase & Co -- that
underwrote Worldcom Inc. securities, according to plaintiffs' law firm
Lerach Coughlin Stoia Geller Rudman & Robbins of San Diego.
Martha Graybow, "Worldcom defendants in $651 mln deal," The Washington
Post, October 27, 2005 ---
http://snipurl.com/wpOct27
Class action suits are troublesome, but
often these are the only resort for bilked investors
You claim the lawyers are the only ones who make
out. That's wrong. So far, despite the fact that that the issuer, Worldcom,
is bankrupt, we have obtained settlements totaling $4.8 billion for
bondholders and $1.2 billion for stockholders. That's the biggest settlement
in history by far for bondholders and the second biggest for stockholders.
These suits are about money and losses, but they are more about rebuilding
confidence in the underlying values of our economic and political
institutions.
Alan G. Hevesi, New York State Comptroller, "Worldcom's World Record
Fraud," The Wall Street Journal, April 8, 2005 ---
http://online.wsj.com/article/0,,SB111292210015601586,00.html?mod=todays_us_opinion
Ebbers Found Guilty
Former Worldcom Chief Executive Bernard J. Ebbers
was convicted of participating in the largest accounting fraud in U.S.
history, handing the government a landmark victory in its prosecution of an
unprecedented spate of corporate scandals. After eight days of
deliberation, the jury found Mr. Ebbers guilty of all nine counts against him,
including conspiracy and securities fraud, related to an $11 billion
accounting fraud at the onetime highflying telecommunications giant. Mr.
Ebbers, 63 years old, now faces the prospect of spending many years in jail.
He is expected to appeal.
"Ebbers Is Convicted In Massive Fraud: Worldcom Jurors Say CEO Had
to Have Known; Unconvinced by Sullivan," The Wall Street Journal,
March 16, 2005; Page A1 --- http://online.wsj.com/article/0,,SB111090709921580016,00.html?mod=home_whats_news_us
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
Heavy price for poor research
J. P. Morgan Chase, which sold billions of dollars in
Worldcom bonds to the public about a year before the company filed for
bankruptcy, agreed yesterday to pay $2 billion to settle investors' claims
that it did not conduct adequate investigation into the financial condition of
Worldcom before the securities were sold. The bank reached its
settlement with Alan G. Hevesi, comptroller of New York and trustee of the New
York State Common Retirement Fund, the lead plaintiff representing investors
who lost money when Worldcom collapsed in 2002.
Gretchen Morgenson, "Bank to Pay $2 Billion to Settle Worldcom
Claims," The New York Times, March 17, 2005 --- http://www.nytimes.com/2005/03/17/business/17worldcom.html
Two More Banks Settle Enron Claims
J.P. Morgan Chase & Co. and Toronto-Dominion Bank
will pay Enron a total of $480 million to settle allegations that they
helped the once-mighty energy giant hide debt and inflate earnings. The
settlement stems from a lawsuit filed by Enron against 10 banks. The suit
contends the banks could have prevented the company's 2001 collapse if they
hadn't “aided and abetted fraud,” the Houston Chronicle reported.
"Two More Banks Settle Enron Claims," AccountingWeb, August 18, 2005
---
http://www.accountingweb.com/cgi-bin/item.cgi?id=101212
Pays to go bankrupt!
MCI predicted a net loss for this year and reported a
massive $22.2 billion profit for 2003 as a result of accounting adjustments
related to the bankruptcy.
Shawn Young, The Wall Street Journal, April 30, 2004, Page B3 --- http://online.wsj.com/article/0,,SB108327600038897861,00.html?mod=technology_main_whats_news
From The Wall Street Journal Accounting Weekly Review on July 22,
2005
TITLE: Ebbers Is Sentenced to 25 Years for $11 Billion Worldcom Fraud
REPORTERS: Dionne Searcey, Shawn Young, and Kara Scannell
DATE: Jul 14, 2005
PAGE: A1
LINK:
http://online.wsj.com/article/0,,SB112126001526184427,00.html
TOPICS: Accounting Fraud, Capital Spending, Accounting, Financial Accounting
SUMMARY: "Bernard J. Ebbers...was sentenced to 25 years in prison for
orchestrating the biggest corporate accounting fraud in U.S. history."
QUESTIONS: 1.) What is the one accounting practice cited in the article
as the basis for committing fraud at Worldcom? In your answer, differentiate
between accounting for capital investments and operating expenditures.
2.) The article describes defense attorneys' and other lawyers' surprise
at the severity of Ebbers's sentence, comparing it to the length of sentence
for criminals who have taken another's life. Who was harmed by this fraud
and how devastating could the harm have been to those victims?
3.) Why is a chief executive officer held responsible for financial
reporting of the entity under his or her command? Why did jurors believe
that Ebbers could not have unaware of the fraud at Worldcom?
Reviewed By: Judy Beckman, University of Rhode Island
Bob Jensen's fraud updates are at
http://www.trinity.edu/rjensen/FraudUpdates.htm
Ten former directors of Worldcom have agreed to
pay $18 million of their own money to settle a lawsuit by investors.
Grechen Morgensen, The New York Times, January 6, 2004 --- http://www.nytimes.com/2005/01/06/business/06tele.html?hp&ex=1105074000&en=b956e943855a1d2b&ei=5094&partner=homepage
"It's just extraordinarily rare for a
director to pay money out of his own pocket," said Michael Klausner, a
law professor at Stanford University who is studying the personal liability of
directors. Mr. Klaus-ner and his fellow researchers have so far found only
four cases from 1968 to 2003 in which directors contributed their own money to
settle a shareholder lawsuit. "It is extremely unusual," he said. If
the settlement deters people from serving on corporate boards, that will run
counter to the interests of institutional investors, who have called for a
greater role for independent directors in corporate governance, Mr. Klausner
said. Newer laws, like the Sarbanes-Oxley Act of 2002, adopted in the wake of
the Enron and Worldcom bankruptcies, are also requiring a greater role for
outside directors.
Jonathan D. Glater, "A Big New Worry for Corporate Directors," The
New York Times, January 6, 2005 --- http://www.nytimes.com/2005/01/06/business/06board.html
Jensen Comment: Why should anybody be
shielded by insurance if they are co-conspirators in fraud?
Bob Jensen's threads on the Worldcom scandal
are at
http://www.trinity.edu/rjensen/FraudEnron.htm#Worldcom
"A Worldcom Settlement Falls Apart," by Gretchen Morgenson, The
New York Times, February 3, 2005 --- http://www.nytimes.com/2005/02/03/business/03tele.html
A landmark settlement last month that had 10 former
Worldcom directors agreeing to pay $18 million from their own pockets to
investors who lost money in the company's failure was scuttled yesterday.
The settlement fell apart after the judge
overseeing the case ruled that one aspect of the deal was illegal because it
would have limited the directors' potential liability and exposed the
investment banks that are also defendants in the case to greater damages.
The lead plaintiff in the case said it could not proceed with the settlement
with that provision removed.
When the settlement was announced, it was hailed as
a rare case where an investor held directors responsible for problems
occurring on their watch. Because yesterday's ruling turned on one technical
aspect of the settlement with the former Worldcom directors, it is not
expected to deter restive shareholders from trying to make corporate board
members accountable.
The ruling by Judge Denise Cote of Federal District
Court in Manhattan - who is presiding over the shareholder suit against
directors and executives from Worldcom, its investment banks and Arthur
Andersen, its auditor - sided with lawyers for the banks, who objected to
the deal almost immediately after it was announced.
The judge's ruling means that the 10 directors will
remain as defendants in the case. As such, they face the possibility of
paying significantly more than they had agreed to in the settlement if they
are found liable by a jury for investor losses.
Federal law states that in cases involving the sale
of securities, as this one does, defendants found liable for losses by a
jury are responsible for the entire amount of the damages. But in 1995, the
Private Securities Litigation Reform Act provided that directors involved in
such a case are responsible only for their part of the fault, as determined
by the jury. This law was intended to protect directors from staggering
damages in such cases.
The settlement with the former Worldcom directors
was unfair to the investment bank defendants, their lawyers argued, because
with the board members no longer named as defendants in the case, the banks
could not reduce their own liability in a verdict by the amount of the
investors' losses that the jury concluded was the responsibility of the
company's former directors.
For example, under the terms of the settlement, the
banks would have been limited to a reduction in damages of $90 million, the
estimated net worth of the directors. A jury might find the directors
responsible for far less.
The settlement, had it gone through, would also
have prevented the banks from being able to sue the directors and possibly
recover money from them. Sixteen banks are named as defendants, including J.
P. Morgan Chase, Deutsche
Bank and Bank
of America.
Continued in the article
From The Wall Street Journal Weekly
Accounting Review on April 1, 2005
TITLE: MCI Warns About Internal Controls
REPORTER: David Enrich
DATE: Mar 17, 2005
PAGE: B5
LINK:
http://online.wsj.com/article/0,,SB111101999280681798,00.html
TOPICS: Auditing, Financial Accounting, Income Taxes, Accounting Information
Systems, Internal Controls, Sarbanes-Oxley Act
SUMMARY: MCI has disclosed material weaknesses in its internal control
over accounting for income taxes and other areas.
QUESTIONS:
1.) Why has MCI uncovered weaknesses in its internal controls? Over what
areas of accounting are its controls in question?
2.) How do the circumstances faced by MCI demonstrate the need to assess
internal controls every year?
3.) Why do you think that the steps undertaken by MCI to resolve its
deficiencies in income tax accounting for the current year are not
sufficient to allow auditors to conclude that the company's income tax
controls are, in general, effective?
4.) The company lists several factors that are particularly difficult
areas in which to consider income tax implications, including fresh-start
accounting, asset impairments, and cancellation of debt. Define each of
these terms. From what transactions do you think each issue arises? For each
term, why do you think that it is particularly difficult to assess income
tax implications?
Reviewed By: Judy Beckman, University of Rhode Island
"Worldcom Case Against Banks To Go to Trial," by Diya Gullapalli,
The Wall Street Journal, December 16, 2004; Page C4 --- http://online.wsj.com/article/0,,SB110315786738701568,00.html?mod=technology%5Fmain%5Fwhats%5Fnews
In a decision that threatens to keep the
underwriters of two bond offerings from Worldcom Inc. embroiled in
litigation, a federal judge yesterday rejected a motion to dismiss a
class-action case by the remaining defendants.
While the firms said they had relied upon auditor
Arthur Andersen LLP's clean bill of health on Worldcom when selling the
bonds, the judge said the underwriters should have done their own legwork to
size up the telecommunications company, which filed for bankruptcy after a
massive accounting fraud.
Continued in the article
Two of the most stunning business collapses of the last few years produced
hefty settlements for some of the victims this week. Current and former Enron
employees received the news on Wednesday of the $85 million partial settlement
in the would-be class action lawsuit.
"Worldcom Investors, Enron Employees Win Settlements," AccountingWEB,
May 13, 2004 --- http://www.accountingweb.com/cgi-bin/item.cgi?id=99161
Two of the most stunning business collapses of the
last few years produced hefty settlements for some of the victims this week.
Citigroup, Inc. on Monday agreed to pay $2.65
billion to investors who claim the firm’s brokerage unit pumped up
Worldcom despite their knowledge of massive losses at the company. The suit,
which sought $54 billion, also alleged that Citigroup's brokerage arm,
Salomon Smith Barney, offered big loans to Worldcom’s then-chief executive
Bernard Ebbers in a swap for investment banking business.
Citigroup, the world's largest bank, denies
wrongdoing. The payout will go to investors who bought Worldcom stock or
bonds and lawyers in the class action, the Washington Post reported.
According to some expert estimates, shareholders lost $2.6 billion in the
Worldcom collapse. Bondholders got about 36 cents on the $1.
Worldcom's $104 billion bankruptcy in 2002 was the
biggest in corporate history, and the $2.65 billion settlement is among the
largest to result from the accounting scandals of the past five years. MCI,
the second-largest U.S. long distance telephone company, emerged from
bankruptcy last month.
In a separate settlement, current and former Enron
employees got news of an $85 million partial settlement Wednesday in the
would-be class action lawsuit. The settlement would benefit 12,000 to 20,000
current and former Enron employees.
If U.S. District Court Judge Melinda Harmon OKs the
deal, it will be late summer or fall before any money is added to the
retirement plans, the Houston Chronicle reported.
The Enron employees who lost millions of dollars in
retirement money say the energy company’s officers failed to execute their
duties in administering the pension plan, which had almost two-thirds of the
employees’ assets in company stock. The stock plummeted from a high of
almost $85 to less than $1 as the company spiraled toward bankruptcy.
The $85 million insurance policy that was handed
over settles claims against human resource employees and company directors,
but not those against former Enron chairman Kenneth Lay and former chief
executive Jeffrey Skilling.
In a related matter, former company directors
agreed to pay a total of $1.5 million to resolve a suit by the U.S.
Department of Labor, which also sought to recover lost retirement money. The
settlement also needs court approval.
Labor Secretary Elaine Chao has said that Lay
"went so far as to tout the (Enron) stock as a good investment for his
own employees — even after he had been warned that a wave of accounting
scandals was about to engulf the corporation," the Associated Press
reported.
Lynn Sarko, a Seattle-based lawyer for the
employees, said much of the lawsuit will still proceed against Lay and
Skilling. "This will be a small piece of the ultimate recovery,"
she said.
March 26, 2004 message from AccountingWEB.com
[AccountingWEB-wire@accountingweb.com]
U.S. Bankruptcy Judge Arthur Gonzalez
has ordered Worldcom to stop paying its external auditor KMPG after 14 states
announced last week that the Big Four firm gave the company advice designed to
avoid some state taxes --- http://www.accountingweb.com/item/98927
AccountingWEB.com - Mar-24-2004 -
U.S. Bankruptcy Judge Arthur Gonzalez has ordered Worldcom to stop paying
its external auditor KMPG after 14 states announced last
week that the Big Four firm gave the company advice designed to avoid
some state taxes.
Worldcom called the
judge’s move a "standard procedural step," which occurs anytime
a party in a bankruptcy proceeding has objections to fees paid to advisors.
A hearing is set for April 13 to discuss the matter, the Wall Street Journal
reported.
Both KPMG and MCI,
which is the name Worldcom is now using, say the states claims are without
merit and expect the telecommunications giant to emerge from bankruptcy on
schedule next month.
"We're very
confident that we'll win on the merits of the motion," MCI said.
Last week, the
Commonwealth of Massachusetts claimed it was denied $89.9 million in tax
revenue because of an aggressive KPMG-promoted tax strategy that helped
Worldcom cut its state tax obligations by hundreds of millions of dollars in
the years before its 2002 bankruptcy filing, the Wall Street Journal
reported.
Thirteen other
states joined the action led by Massachusetts Commissioner of Revenue Alan
LeBovidge, who filed documents last week with the U.S. Bankruptcy Court for
the Southern District of New York. The states call KPMG’s tax shelter a
"sham" and question the accounting firm’s independence in acting
as Worldcom’s external auditor or tax advisor, the Journal reported.
KPMG disputes the
states’ claims. George Ledwith, KPMG spokesman, told the Journal,
"Our corporate-tax work for Worldcom was performed appropriately, in
accordance with professional standards and all rules and regulations, and we
firmly stand behind it. We are confident that KPMG remains disinterested as
required for all of the company's professional advisers in its role as
Worldcom's external auditor. Any allegation to the contrary is
groundless."
A FeloniousParent Takes on the Name of Its Juvenile Delinquent
Child
"Worldcom Changes Its Name and Emerges From Bankruptcy," by
Kenneth N. Gilpin, The New York Times, April 20, 2004 --- http://www.nytimes.com/2004/04/20/business/20CND-MCI.html
Worldcom Inc. emerged from federal bankruptcy
protection this morning with the new name of MCI, about 21 months
after the scandal-tainted company sought protection from creditors in
the wake of an $11 billion accounting fraud.
"It really is a great day for the
company," Michael D. Capellas, MCI's president and chief
executive, said in a conference call with reporters. "We come out
of bankruptcy with virtually all of our core assets intact. But it's
been a marathon with hurdles."
The bankruptcy process has allowed MCI to
dramatically pare its debt from $41 billion to about $6 billion. And
although that cutback will reduce debt service payments by a little
more than $2 billion a year, the company still faces some hurdles in
its comeback effort.
In addition to changing its new name, the
company added five people to its board.
Richard Breeden, the former chairman of the
Securities and Exchange Commission who serves as MCI's court-appointed
monitor, has imposed some restrictions on board members to make their
actions more transparent. Those include a requirement that directors
give two weeks' notice before selling MCI stock.
Even though MCI has emerged from bankruptcy,
Judge Jed S. Rakoff, the federal district judge who oversaw the
S.E.C.'s civil lawsuit against the company, has asked Mr. Breeden to
stay on for at least two years.
For the time being, MCI shares will trade
under the symbol MCIAV, which has been the symbol since the company
went into bankruptcy.
Peter Lucht, an MCI spokesman, said it will
be "several weeks, not months" before MCI lists its shares
on the Nasdaq market.
In early morning trading, MCIAV was quoted at
$18, down $1.75 a share.
It was just about a year ago that Worldcom
unveiled its reorganization plan, which included moving its
headquarters from Clinton, Miss., to Ashburn, Va., and renaming the
company after its long-distance unit, MCI.
Worldcom had merged with MCI in a transaction
that was announced in 1997.
Although its outstanding debt has been
dramatically reduced, MCI faces daunting challenges, not the least of
which are pricing pressures in what remains a brutally competitive
telecommunications industry.
MCI has already warned it expects revenues to
drop 10 percent to 12 percent this year.
To offset the revenue decline, the company
has taken steps to cut costs.
Last month, MCI announced plans to lay off
4,000 employees, reducing its work force to about 50,000.
"It's going to be a tough year,"
Mr. Capellas said. "But the good news about our industry is that
people do communicate, and they communicate in more ways."
Mr. Capellas cited four areas where he saw
growth potential for MCI: increased business from the company's
current customers; global expansion; additions to MCI's array of
products; and expansion of the company's security business.
"Even though there are certain areas in
the industry that are compressing, we think there is some space to
grow," he said.
In the course of the bankruptcy, MCI said it
lost none of its top 100 customers. And in January the federal
government, which collectively is MCI's biggest customer, lifted a
six-month ban that had prohibited the company from bidding for new
government contracts.
To a certain extent, MCI's growth prospects
will be hampered by its bondholders, whose primary interest is to
ensure they are repaid for their investment as soon as possible.
Even though many who contributed to the
Worldcom scandal are gone, it will probably be some time before
memories of what happened fade.
All of the senior executives and board
members from the time when Bernard Ebbers was chief executive are no
longer with the company.
Five executives, including Scott Sullivan,
Worldcom's former chief financial officer, have pleaded guilty to
federal charges for their roles in the scandal and are cooperating
with the government in its investigation.
Mr. Ebbers has pleaded innocent to charges
including conspiracy and securities fraud.
What are the three main
problems facing the profession of accountancy at the present time?
One nation,
under greed, with stock options and tax shelters for all.
Proposed revision of the U.S. Pledge of Allegiance following a June 26, 2002
U.S. court decision that the present version is unconstitutional.
On June 26, 2002, the SEC charged
Worldcom
with massive accounting fraud in a scandal that will surpass the Enron scandal
in losses to shareholders, creditors, and jobs. Worldcom made the
following admissions on June 25, 2002 at http://www.worldcom.com/about_the_company/press_releases/display.phtml?cr/20020625
CLINTON, Miss., June
25, 2002 – Worldcom, Inc. (Nasdaq: WCOM, MCIT) today announced it intends to
restate its financial statements for 2001 and the first quarter of 2002. As a
result of an internal audit of the company’s capital expenditure accounting,
it was determined that certain transfers from line cost expenses to capital
accounts during this period were not made in accordance with generally
accepted accounting principles (GAAP). The amount of these transfers was
$3.055 billion for 2001 and $797 million for first quarter 2002. Without these
transfers, the company’s reported EBITDA would be reduced to $6.339 billion
for 2001 and $1.368 billion for first quarter 2002, and the company would have
reported a net loss for 2001 and for the first quarter of 2002.
The company promptly
notified its recently engaged external auditors, KPMG LLP, and has asked KPMG
to undertake a comprehensive audit of the company’s financial statements for
2001 and 2002. The company also notified Andersen LLP, which had audited the
company’s financial statements for 2001 and reviewed such statements for
first quarter 2002, promptly upon discovering these transfers. On June 24,
2002, Andersen advised Worldcom that in light of the inappropriate transfers
of line costs, Andersen’s audit report on the company’s financial
statements for 2001 and Andersen’s review of the company’s financial
statements for the first quarter of 2002 could not be relied upon.
The company will
issue unaudited financial statements for 2001 and for the first quarter of
2002 as soon as practicable. When an audit is completed, the company will
provide new audited financial statements for all required periods. Also,
Worldcom is reviewing its financial guidance.
The company has
terminated Scott Sullivan as chief financial officer and secretary. The
company has accepted the resignation of David Myers as senior vice president
and controller.
Worldcom has notified
the Securities and Exchange Commission (SEC) of these events. The Audit
Committee of the Board of Directors has retained William R. McLucas, of the
law firm of Wilmer, Cutler & Pickering, former Chief of the Enforcement
Division of the SEC, to conduct an independent investigation of the matter.
This evening, Worldcom also notified its lead bank lenders of these events.
The expected
restatement of operating results for 2001 and 2002 is not expected to have an
impact on the Company’s cash position and will not affect Worldcom’s
customers or services. Worldcom has no debt maturing during the next two
quarters.
“Our senior
management team is shocked by these discoveries,” said John Sidgmore,
appointed Worldcom CEO on April 29, 2002. “We are committed to operating
Worldcom in accordance with the highest ethical standards.”
“I want to assure
our customers and employees that the company remains viable and committed to a
long-term future. Our services are in no way affected by this matter, and our
dedication to meeting customer needs remains unwavering,” added Sidgmore.
“I have made a commitment to driving fundamental change at Worldcom, and
this matter will not deter the new management team from fulfilling our
plans.”
Actions to Improve
Liquidity and Operational Performance
As Sidgmore
previously announced, Worldcom will continue its efforts to restructure the
company to better position itself for future growth. These efforts include:
Cutting capital
expenditures significantly in 2002. We intend 2003 capital expenditures will
be $2.1 billion on an annual basis.
Downsizing our
workforce by 17,000, beginning this Friday, which is expected to save $900
million on an annual basis. This downsizing is primarily composed of
discontinued operations, operations & technology functions, attrition and
contractor terminations.
Selling a series of
non-core businesses, including exiting the wireless resale business, which
alone will save $700 million annually. The company is also exploring the sale
of other wireless assets and certain South American assets. These sales will
reduce losses associated with these operations and allow the company to focus
on its core businesses.
Paying Series D, E
and F preferred stock dividends in common stock rather than cash, deferring
dividends on MCI QUIPS, and discontinuing the MCI tracker dividend, saving
approximately $375 million annually.
Continuing
discussions with our bank lenders.
Creating a new
position of Chief Service and Quality Officer to keep an eye focused on our
customer services during this restructuring.
“We intend to
create $2 billion a year in cash savings in addition to any cash generated
from our business operations,” said Sidgmore. “By focusing on these steps,
I am convinced Worldcom will emerge a stronger, more competitive player.”
Verizon,
one of MCI's most outspoken opponents, never filed a lawsuit against MCI. But
last spring, the company's general counsel, William Barr, said MCI had operated
as "a criminal enterprise," referring to the company's accounting
fraud. Mr. Barr also argued that the company should be liquidated rather than
allowed out of bankruptcy. Mr. Barr couldn't be reached for comment Monday.
Commenting on the settlement, Verizon spokesman Peter Thonis said, "we
understand that this is still under criminal investigation and nothing has
changed in that regard."
Shawn Young, and Almar Latour, The Wall Street Journal,
February 24, 2004 --- http://online.wsj.com/article/0,,SB107755372450136627,00.html?mod=technology_main_whats_news
"U.S. Indicts Worldcom Chief Ebbers," by Susan Pullam, almar Latour, and ken Brown, The Wall Street
Journal, March 3, 2004 --- http://online.wsj.com/article/0,,SB107823730799144066,00.html?mod=home_whats_news_us
In Switch, CFO Sullivan Pleads
Guilty,
Agrees to Testify Against Former Boss
After trying for two years to build
a case against Bernard J. Ebbers, the federal government finally charged
the man at the top of Worldcom Inc., amid growing momentum in the
prosecution of the big 1990s corporate scandals.
Mr. Ebbers was indicted Tuesday for
allegedly helping to orchestrate the largest accounting fraud in U.S.
history. The former chairman and chief executive, who had made Worldcom
into one of the biggest stock-market stars of the past decade, was charged
with securities fraud, conspiracy to commit securities fraud and making
false filings to regulators.
After a grueling investigation,
prosecutors finally got their break from an unlikely source: Scott
Sullivan, Worldcom's former chief financial officer. He had vowed to fight
charges against him and was set to go to trial in late March. But instead,
after a recent change of heart, he pleaded guilty Tuesday to three charges
just before Mr. Ebbers's indictment was made public. Mr. Sullivan also
signed an agreement to cooperate in the case against his former boss.
The indictment, which centers
around the two executives' private discussions as they allegedly conspired
to mislead investors, shows that Mr. Sullivan's cooperation already has
yielded big results for prosecutors. "Ebbers and Sullivan agreed to
take steps to conceal Worldcom's true financial condition and operating
performance from the investing public," the indictment stated.
Worldcom, now known as MCI, is one
of the world's largest telecommunications companies, with 20 million
consumer and corporate customers and 54,000 employees. The company's
investors lost more than $180 billion as the accounting fraud reached $11
billion and drove the company into bankruptcy. Ultimately almost 20,000
employees lost their jobs.
Attorney General John Ashcroft
traveled to New York Tuesday to announce the indictment, as years of
prosecutors' efforts in Worldcom and other big corporate fraud cases
finally start to bear fruit. Little progress had been made in the Worldcom
case since five employees pleaded guilty to fraud charges in the summer of
2002. As outrage over the wave of corporate scandals built, prosecutors
struggled with several key puzzle pieces as they sought to assign blame
for the corporate wrongdoing.
They were initially unable to make
cases against Mr. Ebbers and Enron Corp. Chief Executive Jeffrey Skilling.
And Mr. Sullivan and former Enron Chief Financial Officer Andrew Fastow
gave every indication that they were going to vigorously fight the charges
against them. Enron, the Houston-based energy company, filed for
bankruptcy-court protection in 2001.
But in recent weeks a lot has
changed. In January Mr. Fastow pleaded guilty and agreed to cooperate with
prosecutors. Soon afterward the government indicted his former boss, Mr.
Skilling. Meanwhile, highly publicized fraud trials of the top executives
of Tyco International Ltd. and Adelphia Communications Corp. are under way
in New York and prosecutors have continued to make plea agreements in the
cases stemming from the fraud at HealthSouth Corp. Two former HealthSouth
executives agreed to plead guilty Tuesday (see article).
Former HealthSouth Chairman Richard Scrushy was indicted last year.
Mr. Ashcroft in his announcement
Tuesday said that two years of work had paid off with more than 600
indictments and more than 200 convictions of executives. "America's
economic strength depends on ... the accountability of corporate
officials," he said.
Mr. Sullivan, a close confidant of
Mr. Ebbers, pleaded guilty to three counts of securities fraud. He
secretly began cooperating with prosecutors in recent weeks, according to
people close to the situation.
Continued in the article
Contrary to the optimism expressed
above, most analysts are predicting that Worldcom will declare bankruptcy in a
matter of months. Unlike the Enron scandal where accounting deception was
exceedingly complex in very complicated SPE and derivatives accounting schemes,
it appears that Worldcom and its Andersen auditors allowed very elementary and
blatant violations of GAAP to go undetected.
This morning on June 27, 2002, I found
some interesting items in the reported prior-year SEC
10-K report for Worldcom and its Subsidiaries:
| |
1999 |
2000 |
2001 |
| Net
income (in millions) |
$4,013 |
$4,153 |
$1,501 |
| Taxes
paid (in millions) |
$106 |
$452 |
$148 |
The enormous disparity between income
reported to the public and taxes actually paid on income are consistent with the
following IRS study:
An IRS study
released this week shows a growing gap between figures reported to investors
and figures reported for tax income. With all the scrutiny on accounting
practices these days, the question is being asked - are corporations telling
the truth to the IRS? To investors? To anyone?
http://www.accountingweb.com/item/83690
Such results highlight the fact that audited GAAP figures reported to
investors have lost credibility. Three problems account for this.
One is that bad audits have become routine such that too many companies either
have to belatedly adjust accounting reports or errors and fraud go
undetected. The second major problem is that the powerful corporate lobby
and its friends in the U.S. Legislature have muscled sickening tax laws and bad
GAAP. The third problem is that in spite of a media show of concern, corporate
America still has a sufficient number of U.S. senators, congressional
representatives, and accounting/auditing standard setters under control such
that serious reforms are repeatedly derailed.
Appeals to virtue and ethics just are not going to solve this problem
until compensation and taxation laws and regulations are fundamentally revised
to impede moral hazard.
One example is the case of employee stock options
accounting. Corporate lobbyists muscled the FASB and the SEC into not
booking stock options as expenses for GAAP reporting purposes. However,
corporate America lobbied for enormous tax benefits that are given to
corporations when stock options are exercised (even though these options are not
booked as corporate expenses). Following the Enron scandal, powerful
investors like Warren Buffet and the Chairman of the Federal Reserve Board, Alan
Greenspan, have made strong efforts to book stock options as expenses, but even
more powerful leaders like George Bush have blocked reform on stock options
accounting
For more details, study the an
examination that I gave to my students in April 2002 --- http://www.cs.trinity.edu/~rjensen/Exams/5341sp02/exam02/
Also see http://www.trinity.edu/rjensen/theory/sfas123/jensen01.htm
For example, in its Year 2000 annual
report, Cisco Systems reported $2.67 billion in profits, but managed to wipe out
nearly all income taxes with a $2.5 billion benefit from the exercise of
employee stock options (ESOs). In a similar manner, Worldcom reported $585
million in 1999 and $124 million in 2000 tax benefits added to paid-in capital
from exercise of ESOs.
One nation,
under greed, with stock options and tax shelters for all.
Proposed revision of the U.S. Pledge of Allegiance following a U.S. June 26,
2002 court decision that the present version is unconstitutional.
Bob Jensen's threads on the state of
accountancy can be found at http://www.trinity.edu/rjensen/FraudConclusion.htm
Citigroup agreed to pay $2.65 billion to settle a
suit brought by investors of the former Worldcom, who lost billions when
the telecom firm filed for Chapter 11. Citigroup said it would take a
$4.95 billion charge in the second quarter.
"Citigroup Will Pay
$2.65 Billion To Settle Worldcom Investor Suit," by Mitchell Pacelle, The Wall Street Journal, May 11, 2004, Page A1 --- http://online.wsj.com/article/0,,SB108419118926806649,00.html?mod=home_whats_news_us
In one of the largest
class-action settlements ever, Citigroup
Inc. agreed to pay $2.65 billion to settle a suit brought by investors
of the former Worldcom Inc., who lost billions when the
telecommunications giant filed for bankruptcy in 2002 after a massive
accounting scandal.
The world's largest
financial-services firm, facing many other lawsuits tied to its role
in other corporate scandals, also announced it was substantially
beefing up its reserves earmarked for pending litigation. Following
the bank's addition of $5.25 billion pretax to reserves, and the
payment of the Worldcom settlement, Citigroup will have $6.7 billion
in litigation reserves remaining.
The actions open an expensive
new chapter in the bank's continuing clean-up efforts. Coming nearly a
year after its last major settlement with regulators, settlement of
the Worldcom lawsuit, which stemmed from Citigroup's underwriting of
Worldcom securities, suggests that resolving complaints from private
investors could be far more costly for the bank than making amends
with the government.
The round of corporate and
investment-banking scandals that shook the markets in 2001 and 2002
led to a spate of regulatory actions against New York-based Citigroup
and other Wall Street titans. In an unprecedented series of pacts last
year, Citigroup and other investment banks settled with regulators at
a collective cost of more than $1 billion. But lawsuits brought by
investors claiming billions of dollars of damages continue to hang
over the banking industry.
Citigroup said it would take a
second-quarter after-tax charge of $4.95 billion, or 95 cents a share,
to cover the settlement and increase in litigation reserves. Other
cases facing the company involve financing that it arranged for energy
giant Enron Corp. before its collapse and alleged abuses in the way it
allocated shares in hot initial public offerings during the
stock-market boom.
The Worldcom settlement itself,
with certain buyers of Worldcom shares and bonds, will cost Citigroup
$1.64 billion after tax, because the $2.65 billion payout is tax
deductible, the company said.
The Worldcom lawsuit, certified
as a class action on behalf of hundreds of thousands of bond and stock
purchasers, alleges that Citigroup and other investment banks that
underwrote about $17 billion of Worldcom bonds in May 2000 and May
2001 didn't conduct adequate due diligence before bringing the
securities to market. Besides Citigroup, the defendants include 17
other underwriters that handled about two-thirds of the bonds,
including J.P.
Morgan Chase & Co., Deutsche
Bank AG and Bank
of America Corp.
The suit also focused in part
on Citigroup's Salomon Smith Barney unit and its former star
telecommunications analyst Jack Grubman, who was accused of touting
Worldcom stock until two months before the telecommunications company
collapsed. The lawsuit alleged that Mr. Grubman knew that his public
statements about Worldcom, which the suit claims helped drive up the
value of the stock, weren't accurate. Mr. Grubman, one of the most
influential Wall Street analysts during the tech boom, left Citigroup
in August 2002 amid allegations of conflict of interest.
Worldcom filed for bankruptcy
protection in July 2002, and recently emerged from court protection
under the name of MCI Corp. Its former bondholders received new stock
and bonds, but its former shareholders received nothing.
Citigroup and Mr. Grubman, as
well as other defendants in the suit, have previously denied the
accusations. Citigroup didn't admit to any wrongdoing under the
settlement Monday.
"I personally believe we
did not participate in any way in fraudulent activities,"
Citigroup's chief executive, Charles Prince, said Monday. But in light
of "the current litigation environment," he said, "I
was not willing to roll the dice for the stockholders to try to score
a big win."
The plaintiffs, led by the New
York State Common Retirement Fund, described the settlement with
Citigroup as the second-largest securities class action settlement
ever, after a $3.2 billion settlement against Cendant Corp. in 2000,
but the largest against a third party in connection with work
conducted for a corporate wrongdoer. MCI wasn't a party to the
settlement.
Continued in article
Worldcom
Inc.'s restated financial
reports aren't even at the
printer yet, and already new
questions are surfacing
about whether investors can
trust the independence of
the company's latest
auditor, KPMG LLP -- and,
thus, the numbers
themselves.
I suspect by now, most of you are aware that after
the world's largest accounting scandal ever, our Denny
Beresford accepted an invitation to join the
Board of Directors at Worldcom. This has been an intense addition to his
day job of being on the accounting faculty at the University of Georgia.
Denny has one of the best, if not the best, reputations for technical skills
and integrity in the profession of accountancy. In the article below, he
is quoted extensively while coming to the defense of the KPMG audit of the
restated financial statements at Worldcom. I might add that Worldcom's
accounting records were a complete mess following Worldcom's deliberate
efforts to deceive the world and Andersen's suspected complicity in the
crime. If Andersen was not in on the conspiracy, then Andersen's
Worldcom audit goes on record as the worst audit in the history of the
world. For more on the Worldcom scandal, go to http://www.trinity.edu/rjensen/fraud.htm#WorldcomFraud
"New Issues Are
Raised Over Independence of
Auditor for MCI," by
Jonathan Weil, The Wall
Street Journal, January
28, 2004 --- http://online.wsj.com/article/0,,SB107524105381313221,00.html?mod=home_whats_news_us
Worldcom Inc.'s restated financial reports aren't
even at the printer yet, and already new questions are surfacing about
whether investors can trust the independence of the company's latest
auditor, KPMG LLP -- and, thus, the numbers themselves.
The doubts stem from a brewing series of disputes
between state taxing authorities and Worldcom, now doing business under the
name MCI, over an aggressive KPMG tax-avoidance strategy that the
long-distance company used to reduce its state-tax bills by hundreds of
millions of dollars from 1998 until 2001. MCI, which hopes to exit
bankruptcy-court protection in late February, says it continues to use the
strategy. Under it, MCI treated the "foresight of top management"
as an asset valued at billions of dollars. It licensed this foresight to its
subsidiaries in exchange for royalties that the units deducted as business
expenses on state tax forms.
It turns out, of course, that Worldcom management's
foresight wasn't all that good. Bernie Ebbers, the telecommunications
company's former chief executive, didn't foresee Worldcom morphing into the
largest bankruptcy filing in U.S. history or getting caught overstating
profits by $11 billion. At least 14 states have made known their intention
to sue the company if they can't reach tax settlements, on the grounds that
the asset was bogus and the royalty payments lacked economic substance.
Unlike with federal income taxes, state taxes won't necessarily get wiped
out along with MCI's restatement of companywide profits.
MCI says its board has decided not to sue KPMG --
and that the decision eliminates any concerns about independence, even if
the company winds up paying back taxes, penalties and interest to the
states. MCI officials say a settlement with state authorities is likely, but
that they don't expect the amount involved to be material. KPMG, which
succeeded the now-defunct Arthur Andersen LLP as MCI's auditor in 2002, says
it stands by its tax advice and remains independent. "We're fully
familiar with the facts and circumstances here, and we believe no question
can be raised about our independence," the firm said in a one-sentence
statement.
Auditing standards and federal securities rules
long have held that an auditor "should not only be independent in fact;
they should also avoid situations that may lead outsiders to doubt their
independence." Far from resolving the matter, MCI's decision not to sue
has made the controversy messier.
In a report released Monday, MCI's Chapter 11
bankruptcy-court examiner, former U.S. Attorney General Richard Thornburgh,
concluded that KPMG likely rendered negligent and incorrect tax advice to
MCI and that MCI likely would prevail were it to sue to recover past fees
and damages for negligence. KPMG's fees for the tax strategy in question
totaled at least $9.2 million for 1998 and 1999, the examiner's report said.
The report didn't attempt to estimate potential damages.
Actual or threatened litigation against KPMG would
disqualify the accounting firm from acting as MCI's independent auditor
under the federal rules. Deciding not to sue could be equally troubling,
some auditing specialists say, because it creates the appearance that the
board may be placing MCI stakeholders' financial interests below KPMG's. It
also could lead outsiders to wonder whether MCI is cutting KPMG a break to
avoid delaying its emergence from bankruptcy court, and whether that might
subtly encourage KPMG to go easy on the company's books in future years.
"If in fact there were problems with
prior-year tax returns, you have a responsibility to creditors and
shareholders to go after that money," says Charles Mulford, an
accounting professor at Georgia Institute of Technology in Atlanta.
"You don't decide not to sue just to be nice, if you have a legitimate
claim, or just to maintain the independence of your auditors."
In conducting its audits of MCI, KPMG also would be
required to review a variety of tax-related accounts, including any
contingent state-tax liabilities. "How is an auditor, who has told you
how to avoid state taxes and get to a tax number, still independent when it
comes to saying whether the number is right or not?" says Lynn Turner,
former chief accountant at the Securities and Exchange Commission. "I
see little leeway for a conclusion other than the auditors are not
independent."
Dennis Beresford, the chairman of MCI's audit
committee and a former chairman of the Financial Accounting Standards Board,
says MCI's board concluded, based on advice from outside attorneys, that the
company doesn't have any claims against KPMG. Therefore, he says, KPMG
shouldn't be disqualified as MCI's auditor. He calls the tax-avoidance
strategy "aggressive." But "like a lot of other tax-planning
type issues, it's not an absolutely black-and-white matter," he says,
explaining that "it was considered to be reasonable and similar to what
a lot of other people were doing to reduce their taxes in legal ways."
Mr. Beresford says he had anticipated that the
decision to keep KPMG as the company's auditor would be controversial.
"We recognized that we're going to be in the spotlight on issues like
this," he says. Ultimately, he says, MCI takes responsibility for
whatever tax filings it made with state authorities over the years and
doesn't hold KPMG responsible.
He also rejected concerns over whether KPMG would
wind up auditing its own work. "Our financial statements will include
appropriate accounting," he says. He adds that MCI officials have been
in discussions with SEC staff members about KPMG's independence status, but
declines to characterize the SEC's views. According to people familiar with
the talks, SEC staff members have raised concerns about KPMG's independence
but haven't taken a position on the matter.
Mr. Thornburgh's report didn't express a position
on whether KPMG should remain MCI's auditor. Michael Missal, an attorney who
worked on the report at Mr. Thornburgh's law firm, Kirkpatrick &
Lockhart LLP, says: "While we certainly considered the
auditor-independence issue, we did not believe it was part of our mandate to
draw any conclusions on it. That is an issue left for others."
Among the people who could have a say in the matter
is Richard Breeden, the former SEC chairman who is overseeing MCI's affairs.
Mr. Breeden, who was appointed by a federal district judge in 2002 to serve
as MCI's corporate monitor, couldn't be reached for comment Tuesday.
KPMG’s
“Unusual Twist”
While KPMG's strategy isn't
uncommon among corporations
with lots of units in
different states, the
accounting firm offered an
unusual twist: Under KPMG's
direction, Worldcom treated
"foresight of top
management" as an
intangible asset akin to
patents or trademarks.
Worldcom
Inc.'s restated financial
reports aren't even at the
printer yet, and already new
questions are surfacing
about whether investors can
trust the independence of
the company's latest
auditor, KPMG LLP -- and,
thus, the numbers
themselves.
I suspect by now, most of you are aware that
after the world's largest accounting scandal ever, our Denny
Beresford accepted an invitation to join
the Board of Directors at Worldcom. This has been an intense
addition to his day job of being on the accounting faculty at the
University of Georgia. Denny has one of the best, if not the best,
reputations for technical skills and integrity in the profession of
accountancy. In the article below, he is quoted extensively while
coming to the defense of the KPMG audit of the restated financial
statements at Worldcom. I might add that Worldcom's accounting
records were a complete mess following Worldcom's deliberate efforts to
deceive the world and Andersen's suspected complicity in the
crime. If Andersen was not in on the conspiracy, then Andersen's
Worldcom audit goes on record as the worst audit in the history of the
world. For more on the Worldcom scandal, go to http://www.trinity.edu/rjensen/fraud.htm#WorldcomFraud
"New Issues Are
Raised Over Independence of
Auditor for MCI," by
Jonathan Weil, The Wall
Street Journal, January
28, 2004 --- http://online.wsj.com/article/0,,SB107524105381313221,00.html?mod=home_whats_news_us
Worldcom Inc.'s restated financial reports
aren't even at the printer yet, and already new questions are
surfacing about whether investors can trust the independence of the
company's latest auditor, KPMG LLP -- and, thus, the numbers
themselves.
The doubts stem from a brewing series of
disputes between state taxing authorities and Worldcom, now doing
business under the name MCI, over an aggressive KPMG tax-avoidance
strategy that the long-distance company used to reduce its state-tax
bills by hundreds of millions of dollars from 1998 until 2001. MCI,
which hopes to exit bankruptcy-court protection in late February, says
it continues to use the strategy. Under it, MCI treated the
"foresight of top management" as an asset valued at billions
of dollars. It licensed this foresight to its subsidiaries in exchange
for royalties that the units deducted as business expenses on state
tax forms.
It turns out, of course, that Worldcom
management's foresight wasn't all that good. Bernie Ebbers, the
telecommunications company's former chief executive, didn't foresee
Worldcom morphing into the largest bankruptcy filing in U.S. history
or getting caught overstating profits by $11 billion. At least 14
states have made known their intention to sue the company if they
can't reach tax settlements, on the grounds that the asset was bogus
and the royalty payments lacked economic substance. Unlike with
federal income taxes, state taxes won't necessarily get wiped out
along with MCI's restatement of companywide profits.
MCI says its board has decided not to sue
KPMG -- and that the decision eliminates any concerns about
independence, even if the company winds up paying back taxes,
penalties and interest to the states. MCI officials say a settlement
with state authorities is likely, but that they don't expect the
amount involved to be material. KPMG, which succeeded the now-defunct
Arthur Andersen LLP as MCI's auditor in 2002, says it stands by its
tax advice and remains independent. "We're fully familiar with
the facts and circumstances here, and we believe no question can be
raised about our independence," the firm said in a one-sentence
statement.
Auditing standards and federal securities
rules long have held that an auditor "should not only be
independent in fact; they should also avoid situations that may lead
outsiders to doubt their independence." Far from resolving the
matter, MCI's decision not to sue has made the controversy messier.
In a report released Monday, MCI's Chapter 11
bankruptcy-court examiner, former U.S. Attorney General Richard
Thornburgh, concluded that KPMG likely rendered negligent and
incorrect tax advice to MCI and that MCI likely would prevail were it
to sue to recover past fees and damages for negligence. KPMG's fees
for the tax strategy in question totaled at least $9.2 million for
1998 and 1999, the examiner's report said. The report didn't attempt
to estimate potential damages.
Actual or threatened litigation against KPMG
would disqualify the accounting firm from acting as MCI's independent
auditor under the federal rules. Deciding not to sue could be equally
troubling, some auditing specialists say, because it creates the
appearance that the board may be placing MCI stakeholders' financial
interests below KPMG's. It also could lead outsiders to wonder whether
MCI is cutting KPMG a break to avoid delaying its emergence from
bankruptcy court, and whether that might subtly encourage KPMG to go
easy on the company's books in future years.
"If in fact there were problems with
prior-year tax returns, you have a responsibility to creditors and
shareholders to go after that money," says Charles Mulford, an
accounting professor at Georgia Institute of Technology in Atlanta.
"You don't decide not to sue just to be nice, if you have a
legitimate claim, or just to maintain the independence of your
auditors."
In conducting its audits of MCI, KPMG also
would be required to review a variety of tax-related accounts,
including any contingent state-tax liabilities. "How is an
auditor, who has told you how to avoid state taxes and get to a tax
number, still independent when it comes to saying whether the number
is right or not?" says Lynn Turner, former chief accountant at
the Securities and Exchange Commission. "I see little leeway for
a conclusion other than the auditors are not independent."
Dennis Beresford, the chairman of MCI's audit
committee and a former chairman of the Financial Accounting Standards
Board, says MCI's board concluded, based on advice from outside
attorneys, that the company doesn't have any claims against KPMG.
Therefore, he says, KPMG shouldn't be disqualified as MCI's auditor.
He calls the tax-avoidance strategy "aggressive." But
"like a lot of other tax-planning type issues, it's not an
absolutely black-and-white matter," he says, explaining that
"it was considered to be reasonable and similar to what a lot of
other people were doing to reduce their taxes in legal ways."
Mr. Beresford says he had anticipated that
the decision to keep KPMG as the company's auditor would be
controversial. "We recognized that we're going to be in the
spotlight on issues like this," he says. Ultimately, he says, MCI
takes responsibility for whatever tax filings it made with state
authorities over the years and doesn't hold KPMG responsible.
He also rejected concerns over whether KPMG
would wind up auditing its own work. "Our financial statements
will include appropriate accounting," he says. He adds that MCI
officials have been in discussions with SEC staff members about KPMG's
independence status, but declines to characterize the SEC's views.
According to people familiar with the talks, SEC staff members have
raised concerns about KPMG's independence but haven't taken a position
on the matter.
Mr. Thornburgh's report didn't express a
position on whether KPMG should remain MCI's auditor. Michael Missal,
an attorney who worked on the report at Mr. Thornburgh's law firm,
Kirkpatrick & Lockhart LLP, says: "While we certainly
considered the auditor-independence issue, we did not believe it was
part of our mandate to draw any conclusions on it. That is an issue
left for others."
Among the people who could have a say in the
matter is Richard Breeden, the former SEC chairman who is overseeing
MCI's affairs. Mr. Breeden, who was appointed by a federal district
judge in 2002 to serve as MCI's corporate monitor, couldn't be reached
for comment Tuesday.
KPMG’s
“Unusual Twist”
While KPMG's strategy isn't
uncommon among corporations
with lots of units in
different states, the
accounting firm offered an
unusual twist: Under KPMG's
direction, Worldcom treated
"foresight of top
management" as an
intangible asset akin to
patents or trademarks.
Bob Jensen's threads
on the Worldcom/MCI scandal
are at http://www.trinity.edu/rjensen/fraud.htm#WorldcomFraud
Bob Jensen's threads on KPMG's recent scandals are at
http://www.trinity.edu/rjensen/fraud.htm#KPMG
The potential claims against KPMG represent the most pressing issue for
MCI. The report didn't have an exact tally of state taxes that may have been
avoided, but some estimates range from $100 million to $350 million. Fourteen
states likely will file a claim against the company if they don't reach
settlement, said a person familiar with the matter.
"MCI Examiner Criticizes KPMG On Tax Strategy," by Dennis K.
Berman, Jonathan Weil, and Shawn Young, The Wall Street Journal, January 27,
2004 --- http://online.wsj.com/article/0,,SB107513063813611621,00.html?mod=technology%5Fmain%5Fwhats%5Fnews
The examiner in MCI's Chapter 11 bankruptcy case
issued a report critical of a "highly aggressive" tax strategy
KPMG LLP recommended to MCI to avoid paying hundreds of millions of dollars
in state income taxes, concluding that MCI has grounds to sue KPMG -- its
current auditor.
MCI quickly said the company would not sue KPMG.
But officials from the 14 states already exploring how to collect back taxes
from MCI could use the report to fuel their claims against the telecom
company or the accounting firm. KPMG already is under fire by the U.S.
Internal Revenue Service for pushing questionable tax shelters to wealthy
individuals.
In a statement, KPMG said the tax strategy used by
MCI is commonly used by other companies and called the examiner's
conclusions "simply wrong." MCI, the former Worldcom, still uses
the strategy.
The 542-page document is the final report by
Richard Thornburgh, who was appointed by the U.S. Bankruptcy Court to
investigate legal claims against former employees and advisers involved in
the largest accounting fraud in U.S. history. It reserves special ire for
securities firm Salomon Smith Barney, which the report says doled out more
than 950,000 shares from 22 initial and secondary public offerings to
ex-Chief Executive Bernard Ebbers for a profit of $12.8 million. The shares,
the report said, "were intended to and did influence Mr. Ebbers to
award" more than $100 million in investment-banking fees to Salomon, a
unit of Citigroup Inc. that is now known as Citigroup Global Markets Inc.
In the 1996 initial public offering of McLeodUSA
Inc., Mr. Ebbers received 200,000 shares, the third-largest allocation of
any investor and behind only two large mutual-fund companies. Despite claims
by Citigroup in congressional hearings that Mr. Ebbers was one of its
"best customers," the report said he had scant personal dealings
with the firm before the IPO shares were awarded.
Mr. Thornburgh said MCI has grounds to sue both
Citigroup and Mr. Ebbers for damages for breach of fiduciary duty and good
faith. The company's former directors bear some responsibility for granting
Mr. Ebbers more than $400 million in personal loans, the report said,
singling out the former two-person compensation committee. Mr. Thornburgh
added that claims are possible against MCI's former auditor, Arthur Andersen
LLP, and Scott Sullivan, MCI's former chief financial officer and the
alleged mastermind of the accounting fraud. His criminal trial was postponed
Monday to April 7 from Feb. 4.
Reid Weingarten, an attorney for Mr.
Ebbers, said, "There is nothing new to these allegations. And it's a
lot easier to make allegations in a report than it is to prove them in
court." Patrick Dorton, a spokesman for Andersen, said, "The focus
should be on MCI management, who defrauded investors and the auditors at
every turn." Citigroup spokeswoman Leah Johnson said, "The
services that Citigroup provided to Worldcom and its executives were
executed in good faith." She added that Citigroup now separates
research from investment banking and doesn't allocate IPO shares to
executives of public companies, saying Citigroup continues to believe its
congressional testimony describing Mr. Ebbers as a "best
customer." An attorney for Mr. Sullivan couldn't be reached for
comment.
The potential claims against KPMG
represent the most pressing issue for MCI. The report didn't have an exact
tally of state taxes that may have been avoided, but some estimates range
from $100 million to $350 million. Fourteen states likely will file a claim
against the company if they don't reach settlement, said a person familiar
with the matter.
While KPMG's strategy isn't uncommon
among corporations with lots of units in different states, the accounting
firm offered an unusual twist: Under KPMG's direction, Worldcom treated
"foresight of top management" as an intangible asset akin to
patents or trademarks. Just as patents might be licensed, Worldcom licensed
its management's insights to its units, which then paid royalties to the
parent, deducting such payments as normal business expenses on state
income-tax returns. This lowered state taxes substantially, as the royalties
totaled more than $20 billion between 1998 to 2001. The report says that
neither KPMG nor Worldcom could adequately explain to the bankruptcy
examiner why "management foresight" should be treated as an
intangible asset.
Continued in the article
Continued in the article
Bob Jensen's threads on KPMG's recent scandals are at
http://www.trinity.edu/rjensen/fraud.htm#KPMG
January
28, 2004 reply from Amy Dunbar
[Amy.Dunbar@BUSINESS.UCONN.EDU]
Jonathan
Weil stated:
Dennis
Beresford, the chairman
of MCI's audit committee
and a former chairman of
the Financial Accounting
Standards Board, says
MCI's board concluded,
based on advice from
outside attorneys, that
the company doesn't have
any claims against KPMG.
Therefore, he says, KPMG
shouldn't be
disqualified as MCI's
auditor. He calls the
tax-avoidance strategy
"aggressive."
But "like a lot of
other tax-planning type
issues, it's not an
absolutely
black-and-white
matter," he says,
explaining that "it
was considered to be
reasonable and similar
to what a lot of other
people were doing to
reduce their taxes in
legal ways."
Dunbar's
comments:
After reading the report
filed by the bankruptcy
examiner, I question the
label
"aggressive."
The tax savings resulted
from the
"transfer" of
intangibles to Mississippi
and DC subsidiaries; the
subs charged royalties to
the other members of the
Worldcom group; the other
members deducted the
royalties, minimizing
state tax, BUT Mississippi
and DC do not tax royalty
income. Thus, a state tax
deduction was generated,
but no state taxable
income. The primary asset
transferred was
"management
foresight." KPMG did
not mention this
intangible in its tax
ruling requests to either
Mississippi or DC, burying
it in "certain
intangible assets, such as
trade names, trade marks
and service marks."
The
examiner argues that
"management
foresight" is not a
Sec. 482 intangible asset
because it could not be
licensed. His conclusion
is supported by Merck
& Co, Inc. v. U.S., 24
Cl. Ct. 73 (1991).
Even
if it was an intangible
asset, there is an
economic substance
argument: "the
magnitude of the royalties
charged was breathtaking
(p. 33)." The total
of $20 billion in
royalties paid in
1998-2001 exceeded
consolidated net income
during that period. The
royalties were payments
for the other group
members' ability to
generate "excess
profits" because of
"management
foresight."
Beresford's
argument that this
tax-planning strategy was
similar to what other
people were doing simply
points out that market for
tax shelters was active in
the state area, as well as
the federal area. The
examiner in a footnote 27
states that the examiner
"does not view these
Royalty Programs to be tax
shelters in the sense of
being mass marketed to an
array of KPMG customers.
Rather, the Examiner's
investigation suggest that
the Royalty Programs were
part of the overall
restructuring services
provided by KPMG to
Worldcom and prepresented
tailored tax advice
provided to Worldcom only
in the context of those
restructurings." I
find this conclusion to be
at odds with the
examiner's discussion of
KPMG's reluctance to
cooperate and "a lack
of full cooperation by the
Company and KPMG. Requests
for interviews were
processed slowly and
documents were produced in
piecemeal fashion."
Although the examiner
concluded that he
ultimately interviewed the
key persons and that he
received sufficient
information to support his
conclusions, I question
whether he had sufficient
information to determine
that KPMG wasn't marketing
this strategy to other
clients. Indeed, KPMG
apparently called this
strategy a "plain
vanilla" strategy to
Worldcom, which implies to
me that KPMG considered
this off-the-shelf tax
advice.
I
worry that if we don't
call a spade a spade, the
"aggressive" tax
sheltering activity will
continue at the state
level. Despite record
state deficits, the states
appear to be unwilling to
enact any laws that could
cause a corporation to
avoid doing business in
that state. In the
"race to the
bottom" for corporate
revenues, the states are
trying to outdo each other
in offering enticements to
corporations. The fact
that additional sheltering
is going on at the state
level, over and above the
federal level, is evident
from the fact that state
tax bases are relatively
lower than the federal
base (Fox and Luna, NTJ
2002). Fox and Luna
ascribe the deterioration
to a combination of
explicit state actions and
tax avoidance/evasion by
buinesses. They discuss
Geoffrey, Inc v. South
Carolina Tax Commission
(1993), which involves the
same strategy of placing
intangibles in a state
that doesn't tax royalty
income. Thus,
the strategy advised by
KPMG may well have been
plain vanilla, but the
fact remains that
management foresight is
not an intangible that can
generate royalties. That
is where I think KPMG
overstepped the bounds of
"aggressive."
What arms-length company
would have paid royalties
to Worldcom for its
management foresight?
Amy
Dunbar
University of Connecticut
January
28, 2004 reply from Dennis Beresford
[dberesfo@TERRY.UGA.EDU]
Amy,
Without
getting into private
matters I would just
observe that one shouldn't
accept at face value
everything that is in the
newspaper - or everything
that is in an Examiner's
report.
Denny
University of Georgia
From The Wall Street Journal
Accounting Educators' Review on January 30, 2004
TITLE: New Issues Are Raised Over Independence of Auditor for MCI
REPORTER: Jonathan Weil
DATE: Jan 28, 2004
PAGE: C1
LINK: http://online.wsj.com/article/0,,SB107524105381313221,00.html
TOPICS: Audit Quality, Auditing, Auditing Services, Auditor Independence, Tax
Evasion, Tax Laws, Taxation
SUMMARY: The financial reporting difficulties at Worldcom Inc. continue as
the independence of KPMG LLP is questioned. Questions focus on auditor
independence.
QUESTIONS:
1.) What is auditor independence? Be sure to include a discussion of
independence-in-fact and independence-in-appearance in your discussion.
2.) Why is auditor independence important? Should all professionals (e.g.
doctors and lawyers) be independent? Support your answer.
3.) Can accounting firms provide tax services to audit clients without
compromising independence? Support your answer.
4.) Does the relationship between KPMG and MCI constitute a violation of
independence-in-fact? Does the relationship between KPMG and MCI constitute a
violation of independence-in-appearance? Support your answers with
authoritative guidance.
Reviewed By: Judy Beckman, University of Rhode Island
Reviewed By: Benson Wier, Virginia Commonwealth University
Reviewed By: Kimberly Dunn, Florida Atlantic University
Bob Jensen's threads on KPMG's recent scandals are at http://www.trinity.edu/rjensen/fraud.htm#KPMG
Note from Bob Jensen
Especially note Amy Dunbar’s excellent analysis (above) followed by a
troubling reply by Chair of MCI’s Audit Committee, Denny Beresford.
I say “troubling,” because all analysts and academics have to work
with are the media reports, interviews with people closest to the situation,
and reports released by MCI and/or government files made public. Sometimes
we have to wait for the full story to unfold in court transcripts.
I have always been troubled by quick judgments that auditors cannot be
independent when auditing financial reports when other professionals in the
firm have provided consulting and tax services. I
don’t think this is the real problem of independence in most instances. The
real problem lies in the dependence of the audit firm (especially a local
office) on the enormous audit fees from a giant corporation like Worldcom/MCI.
The risk of losing those fees overshadows virtually every other threat
to auditor independence.
Although I think Amy’s analysis is brilliant in
analyzing the corporate race to the bottom in tax reporting and the assistance
large accounting firms provided in winning the race to the bottom, I don’t
think the threat that KPMG’s controversial tax consulting jeopardized
auditor independence nearly as much as the huge fixed cost KPMG invested in
taking over a complete mess that Andersen left at the giant Worldcom/MCI. It
will take KPMG years to recoup that fixed cost, and I’m certain KPMG will do
everything in its power to not lose the client.
On the other hand, the Worldcom/MCI audit is now the focal point of
world attention, and I’m virtually certain that KPMG is not about to put its
worldwide reputation for integrity in auditing in harms way by performing a
controversial audit of Worldcom/MCI at this juncture. KPMG
has enough problems resulting from prior legal and SEC pending actions to add
this one to the firm’s enormous legal woes at this point in time.
Hi Mac,
I agree with the 15% rule Mac, but much depends upon whether you are
talking about the local office of a large accounting firm versus the global
firm itself. My best example is the local office of Andersen in Houston.
Enron's auditing revenue in that Andersen office was about $25 million.
Although $25 million was a very small proportion of Andersen's global auditing
revenue, it was so much in the local office at Houston that the Houston
professionals doing the audit under David Duncan were transformed into a much
older "profession of the world" in fear of losing that $25 million.
Also there is something different about consulting revenue vis-à-vis
auditing revenue. The local office in charge of an audit may not even know
many of the consultants on the job since many of an accounting firm's
consultants, especially in information systems, come from offices other than
the office in charge of the audit.
Years ago (I refuse to say how many) I was a lowly staff auditor for
E&Y on an audit of Gates Rubber Company in Denver. We stumbled upon a team
of E&Y data processing consultants from E&Y in the Gates' plant. Our
partner in charge of the Gates audit did not even know there were E&Y
consultants from Cleveland who were hired (I think subcontracted by IBM) to
solve an data processing problem that arose.
Bob Jensen
-----Original Message-----
From: MacEwan Wright, Victoria University Sent: Friday, January 30, 2004
5:21 PM
Subject: Re: Case Questions on Independence of Auditor for MCI
Dear Bob,
Given that, on average, consulting fees used to
represent around 50% of fees from a client, the consulting aspect tended to
reinforce the fee dependency. The old ethical rule in Australia that 15% of
all fees could come from one client was probably too large. A 15% drop in
revenue would severely cramp the style of a big practice. Regards,
Mac Wright
"Worldcom to Write Down $79.8 Billion of Good Will," by Simon
Romero, The New York Times, March 14, 2003
Worldcom, the long-distance carrier that is mired
in the nation's largest bankruptcy filing, said yesterday that it was
writing down $79.8 billion of its good will and other assets. The move is an
acknowledgment that many areas of the company's vast telecommunications
network are essentially worthless. The company said in a statement that all
existing good will, valued at $45 billion, would be written down. Worldcom
also said it would reduce the value of $44.8 billion of equipment and other
intangible assets to about $10 billion. Worldcom had previously signaled
that it was considering the write-downs, but the immensity of the values
involved surprised some analysts. Worldcom's write-downs are second only to
those of AOL Time Warner, which recently wrote down nearly $100 billion of
assets.
Continued in the article.
March 12, 2003 message from David
Albrecht [albrecht@PROFALBRECHT.COM]
I finished reading
Disconnected: Deceit and Betrayal at Worldcom, by Lynne W. Jeter
Here is my review
of the book submitted to Amazon.
Why to buy this
book: This book will bring you up to speed on Worldcom.
What this book
does: (1) gives a fact-based history of Worldcom from start (1984) to just
past the end (December, 2002), (2) identifies and discusses key figures in
the rise and fall, (3) introduces the foibles of Ebbers, (3) describes the
clash of corporate culture following of MCI acquisition (4) describes
accounting coverup in broad terms (5) suggests five reasons for the fall:
denial of Sprint takeover, inability to integrate and manage MCI, costly
excess capacity entering the business slowdown of 2000-2003, revenue loss as
a result of long-distance competition, Ebbers inadequacies.
What this book does
not: (1) provide acceptable levels of detail in the acquisitions, (2) give
enough detail for the strengths and weaknesses of key figures, (3) provide
sufficient detail about the accounting cover up, (4) thoroughly analyze each
of the reasons the reasons for the fall.
The author is
somewhat confused by accounting terms, and perhaps about what the accounting
issues were.
After reading this
book, you will be ready for (and need to read) the next books that come out
on Worldcomm. At least, I want to know more about it.
Having panned the
book, I still would recommend it to my students.
David Albrecht
Bowling Green State University
Hi Janko,
Worldcom will go down in history as one of the worst audits in the history
of the world. It was a far worse audit by Andersen than the Andersen
audit of Enron.
Worldcom is not the most exciting
research study, because the fraud was so simple. It is, however, an
interesting study of how bad audits were becoming as audit firms commenced to
succumb to client pressures, especially very large clients like Worldcom.
The main GAAP violations at Worldcom
concerned booking of expenses as assets --- over $3 billion overstated. The
company also violated revenue recognition rules in GAAP. Many of the GAAP
violations are summarized in the recent class action lawsuit against Worldcom
--- http://www.whafh.com/cases/complaint/worldcomcmplt.htm
*****************************************
NATURE OF THE
ACTION
This is a class
action on behalf of a class (the "Class") of all persons who
purchased or otherwise acquired the securities of Worldcom Corporation
between February 10, 2000 and November 1, 2000 (the "Class Period),
seeking to pursue remedies under the Securities Exchange Act of 1934
("1934 Act").
During the Class
Period, defendants, including Worldcom, its Chief Executive Officer, Bernard
Ebbers and its Chief Financial Officer, Scott Sullivan, issued a series of
false statements to the investing public. During the Class Period, Worldcom
reported seemingly unstoppable growth in revenue and profitability despite
unprecedented competition in the telecommunications industry, transforming
Worldcom into the second largest long-distance carrier in the United States,
second only to industry giant AT&T. Indeed, Worldcom, headed by Ebbers
and Sullivan, acquired billions of dollars worth of companies in the span of
a few years - - including the then largest merger ever, the 1998 MCI merger.
Throughout the Class Period, defendants represented that the massive MCI
merger was an enormous success - contributing heavily to synergies, revenues
and growth.
As defendants knew,
due to industry-wide pressure, there was simply no way to continue the
significant revenue and earnings growth the market had come to demand from
Worldcom absent further consolidation. To that end, Ebbers in October, 1999
announced Worldcom’s largest merger ever, a deal to merge with number
three in t |
