History of Proposed Accounting and Auditing Reforms in the Wake of the Enron Scandal

Bob Jensen at Trinity University

Questions
Note the phrase below that reads "including what is left of Arthur Andersen."

• For what does one pay what is left of Andersen (AA) for anything other than training in St Charles?

• Does AA still have offices in some cities other than St Charles?
  (AA is no longer allowed to perform audit services)

• Do the $20 million in 2006 really compare with the $4 million in 2001 in terms of what services are purchased?

• Is Mr. Wilxox giving credit where credit is due for the role Sarbox played in keeping investors from bailing out of corporate securities investment after the very serious accounting scandals of the creative accounting cookery (crookery) of the 1990s? Sarbox makes auditing of his firm more expensive, but Sarbox may have helped save the revenue stream of his financial services firm.

"Critics See Some Good From Sarbanes-Oxley:   As Law Turns Five, They Say It's Too Costly, But It Exposes Problems Before They Explode," by Joann S. Lublin and Kara Scannell, The Wall Street Journal, July 30, 2007; Page B1 --- Click Here

But even critics acknowledge the law has done some good. "There is without question greater accountability in the boardroom," says Thomas Lehner, an official of the Business Roundtable, a Washington group representing big-company CEOs. More boards resolve potential problems "before they fester and explode," concurs John Olson, a senior partner at Gibson, Dunn & Crutcher who advises directors at about a dozen concerns.

And institutional shareholders hurt by the scandals applaud the law's impact. "Sarbanes-Oxley really has been a critical safeguard in reassuring investors and restoring confidence in the integrity of companies' financial statements," says Dan Pedrotty, head of the AFL-CIO's Office of Investment.

The Sarbanes-Oxley statute demanded more rigorous internal controls, forced top executives to certify the accuracy of financial results and created a watchdog for auditing firms. It also expanded the role of board audit committees and required companies to take "whistleblower" complaints more seriously. Related stock-exchange rules bolstered boardroom independence by requiring regular private sessions of independent directors, among other changes.

"In the minds of the investing public, those are important safeguards, and I think in fact they are," Mr. Lehner says.

Continued in article

Sarbanes-Oxley Lowers Corporate Fraud Lawsuits
After five years, the Sarbanes-Oxley law has reduced corporate fraud. It was crafted to restore investor confidence with tighter rules for audits and forcing executives to certify financial statements. Chris Cox, chairman of the Securities and Exchange Commission, talks with Renee Montagne.
NPR, August 2, 2007 --- http://www.npr.org/templates/story/story.php?storyId=12555895

A powerful argument for Sarbox can be made simply by examining the performance of financial markets since the landmark act was passed. Though Sarbox certainly can't take full credit, the U.S. stock market (as measured by the S&P 500) has increased 67%, or about $4.2 trillion in market value, between July 30, 2002 and June 30, 2007. Even John Thain, CEO of the New York Stock Exchange (NYSE) and no great fan of Sarbox, concedes "There is no question that, broadly speaking, Sarbanes-Oxley was necessary."
Thomas J. Healey, "Sarbox Was the Right Medicine," The Wall Street Journal, August 9, 2007; Page A13 --- http://online.wsj.com/article/SB118662443703492573.html?mod=opinion&ojcontent=otep

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

"Dealing With Sarbox," by Kenneth Wilcox, The Wall Street Journal, June 1, 2007; Page A13 --- http://online.wsj.com/article/SB118066527244221047.html?mod=opinion&ojcontent=otep

My own company (SVB Financial Group, which trades on the Nasdaq) is likely indicative. In 2006 we paid over $20 million to the Big Four (including what is left of Arthur Andersen), for an average of about $17,000 per employee. This is more than five times as much as we paid them only three years ago.

It turns out, however, that only a diminishing portion of this increase is due to Sarbox. More and more of it is due to the significantly increased amount of time that audits are taking, and the much larger number of people that they involve. Trying to tease out exactly why they are taking longer and why more people are involved is difficult. When I ask, I get a host of different but related answers. The auditors are operating with droves of often newly hired and therefore inexperienced people. They appear to have lost any sense of the time-honored accounting concept of "materiality." They appear to have very little decision-making power. Decisions, which increasingly need to be sent to superiors in far-away locations, take much longer than just a few years ago.

Nobody appears to want to exercise judgment, either with respect to the applicability of a given Financial Accounting Standards Board (FASB) pronouncement, or to its application. Rules are applied, whether the original framers were targeting the situation at hand or not. And testing takes forever. In situations where just a few years ago just a few tests might have sufficed, today several times as many may be required. Finally, everybody seems to be operating from a position of fear, of rejection or remonstrance.

When I ask about the causes of that, I am told the following: Neither companies nor auditors can really understand all of the primary accounting pronouncements coming out of the FASB, the number of which has gone from 104 in 1989 to 159 today. Many of them are 50 pages or more in length with accompanying interpretations that may be 10 times as long as the pronouncement itself.

The Public Company Accounting Oversight Board (PCAOB) discourages the auditors from either offering advice or exercising judgment. Instead, auditors apply rules, whether they were meant to apply or not, and in the most draconian manner possible, out of fear of reprisal from above.

The SEC is contributing to the fear factor as well, and in many of the same ways as the PCAOB. As a result, almost 10% of all publicly traded companies announced restatements in 2006. Finally, market factors, namely supply and demand, have added to the turmoil. There are nowhere near enough accountants available to staff these greatly expanded audits, which has helped to drive up their price significantly.

We seem to have created a self-reinforcing system which is difficult to adjust. Every aspect of it appears to reinforce the workings of the whole, and no one appears to be either able or willing to help us break out of it. There is a lot of finger-pointing, but very little leadership and -- as a result -- very little relief.

Is this really the system that we want for our economy? Is it really serving the shareholders of our publicly traded companies in a way that justifies the cost? Are we really helping to make America a better place to live and work? Or are we punishing the many for the crimes of the few because, in the end, it's just plain easier?

Bob Jensen's threads on the setting of accounting standards are at
http://www.trinity.edu/rjensen//theory/00overview/theory01.htm#MethodsForSetting

Study: Most Audit Committees Lack Accountant
Then why call them audit committees?
A new report says that in 2005 the number of accountants sitting on audit committees doubled compared to four years prior, but that six out of 10 companies still did not have at least one accountant on their committee. The research from Huron Consulting is based on a sample of more than 700 audit committee members at 178 public companies from the NASDAQ 100 and Fortune 100 listings. The report analyzed patterns of audit committee composition between 2002 and 2005 using information contained in the companies' annual proxy statements and 10-K disclosures filed with the U.S. Securities and Exchange Commission.
"Study: Most Audit Committees Lack Accountant ," SmartPros, November 30, 2006 --- http://accounting.smartpros.com/x55639.xml

"Largest Accounting Firms See Coming Revolution in Business Reporting," AccountingWeb, November 27, 2006 --- http://www.accountingweb.com/cgi-bin/item.cgi?id=102827

As part of the Global Public Policy Symposium in Paris, held on November 8 and attended by key players concerned with ensuring the quality and reliability of financial reporting worldwide, the Chief Executive Officers (CEOs) of PricewaterhouseCoopers (PwC) International, Grant Thornton International, Deloitte, KPMG International and Ernst & Young, published a joint statement of their vision of what the future might hold for financial reporting and the accounting profession.

Entitled “Global Capital Markets and the Global Economy: A Vision from the CEOs of the International Audit Networks,” the document envisions investors having access to real time company financial information through XBRL, financial statements that go beyond reporting past performance to projecting future performance based on information about business intangibles that are not currently measured, and a recommendation that companies choose to supplement regular audits with periodic forensic audits. The report may be viewed at www.globalpublicpolicysymposium.com/

“This essay is about one type of information and its importance to all actors in the global economy; information about the performance of management and companies that make and deliver goods and services, and compete for capital,” the symposium paper says.

In a letter to the Wall Street Journal published on November 8, the day their paper was released, the CEOs wrote that when the basics of current accounting procedures were written, the world’s investors were more a “private club than a global network. Auditors used fountain pens, capital stayed pooled in a few financial centers, and information moved by runner.” The world has changed since then.

In the short term, the letter says, it will be necessary to proceed as rapidly as possible with convergence in international accounting standards, and with overcoming national differences in oversight of auditors and in enforcement.

In the longer term, auditors themselves must evaluate the usefulness to investors of information provided in the current financial statement and footnote format and consider the inclusion of more nonfinancial information.

But, the CEOs say in the Journal letter, “All of these steps should include an emphasis on allowing auditors greater room to exercise judgment. Accountants and auditors are trained professionals who have the ability to apply the spirit of broad principles in deciding how to account for and report financial and other information. . . . Such [future] measures should also include an honest assessment of the “expectations gap,” relating to material fraud and the ability of auditors to uncover it at a reasonable cost.”

The paper looks forward to a world “where users increasingly will want to customize the information they receive” in which “the process for recording and classifying business information will be as important, if not more important, than the static formats in which today’s financial information is reported. Our jobs as auditors, must therefore change to increasing focus on those business processes.”

An “important enabler” of future reporting will be the Global XBRL Initiative, the paper says. XBRL users will be able to view company data in any language, any currency and under different accounting systems and get immediate answers to queries. “In fact the new world is already here for the approximately 40,000 companies that already use XBRL to input their data. . . . China, Spain, the Netherlands and the United Kingdom have required companies to use XBRL.”

The paper acknowledges that investors, analysts and others will still want standardized reports to be issued by public companies on a regular basis. But the CEOs say that investors have told them they want more relevant information to be included. “The large discrepancies between the “book” and “market” values of many, if not most, public companies similarly provide strong evidence of the limited usefulness of statements of assets and liabilities that are based on historical costs. A range of intangibles, such as employee creativity and loyalty and relationships with suppliers and customers, can drive a company’s performance, yet the value of these intangibles is not consistently reported."

In short, the CEO’s vision states “the same forces that are reshaping economies at all levels are driving the need to transform what kind of information various stakeholders want from companies, in what form, and at what frequency. In a world of “mass customization,” standard financial statements have less and less meaning and relevance. The future of auditing in such an environment lies in the need to verify that the process by which company-specific information is collected, sorted and reported is reliable and the information presented is relevant for decision making.”

Investors and regulatory bodies may expect auditors to go further than is reasonable to detect fraud and the paper recommends that all companies be subjected to a regular forensic audit, or be subjected to forensic audits on a random basis.

Another option would be introducing more choice regarding the intensity of audits for fraud. For example, since forensic audits are conducted primarily for the benefit of investors, one possibility would be to let shareholders decide on the intensity of the fraud detection effort
they want auditors to perform. Shareholders could be assisted in making this decision by disclosure in the proxy materials of the costs of the different levels of audits, as well as the historical experience of the company with fraud.

The CEO paper calls for both liability reform and scope of service reform.

Considering the “Brave New World” of auditing envisioned in the document and the scope of the questions it raises, “Global Capital Markets and the Global Economy” has received little attention in the financial press, Motley Fool reports. But, while approving the idea of more timely information flows for the investor, Fool says, “enough companies have trouble meeting their reporting obligations as it is. I would prefer to both maintain those reports and supplement them with additional data.”

That financial reporting will evolve and change is inevitable, the International Herald Tribune says, but whether large accounting firms will lead the dialogue is another matter that may be influenced by their “life-threatening litigation risks.”

Bob Jensen's threads on accounting theory are at http://www.trinity.edu/rjensen//theory/00overview/theory01.htm

"Accounting Firms Seek Overhaul," by Tad Kopinski, Institutional Shareholder Services ISS, November 20, 2006 ---
http://blog.issproxy.com/2006/11/accounting_firms_seek_overhaul.html

The six biggest international audit firms have called for a complete overhaul of corporate financial reporting as the U.S. and Europe move toward convergence of international audit standards.

In a Nov. 8 report, the accounting firms propose to replace static quarterly financial statements with real-time, Internet-based reporting that encompasses a wider range of performance measures, including non-financial ones. The report was signed by the chiefs of PricewaterhouseCoopers International, Grant Thornton International, Deloitte, KPMG International, BDO International, and Ernst & Young. The report can be downloaded here.

"We all believe the current model is broken," Mike D. Rake, KPMG's chairman, told the Financial Times. "There are significant shortcomings to U.S. GAAP [Generally Accepted Accounting Principles] and issues of concern with International Financial Reporting Standards. We're not in a very happy situation."

Rake noted that quarterly reporting and the short-term focus on companies' ability to meet Wall Street earnings expectations helped foster accounting scandals. The firms have been working on their proposals for more than a year.

The large discrepancy between the "book" and "market" values of many listed companies is clear evidence that the content of traditional financial statements is of limited use, the report said. The audit firms recommend using non-financial measures that would provide more valuable indications of a company's future prospects, such as customer satisfaction, product or service defects, employee turnover, and patent awards.

The report said the following developments need to occur to ensure capital market stability, efficiency, and growth:

--Investor needs for information are well defined and met;
--The roles of the various stakeholders in these markets--financial statement preparers, regulators, investors, standards setters, and auditors--are aligned and supported by effective forums for continuous dialogue;
--The auditing profession is vibrant, sustainable, and provides sufficient choice for all stakeholders in these markets;
--A new business-reporting model is developed to deliver relevant and reliable information in a timely way;
--Large, collusive frauds are more and more rare; and
--Information is reported and audited pursuant to globally consistent standards.
 

ICGN Expresses Concerns Over Convergence

Meanwhile, the International Corporate Governance Network (ICGN) has expressed concerns about a draft proposal on harmonizing international and U.S. accounting standards. The ICGN argues that the draft doesn't pay sufficient attention to shareholder rights and the stewardship role of boards and investors.

"Convergence must be there to raise standards," ICGN Executive Director Anne Simpson told the Financial Times. "Convergence for its own sake is not of value."

The ICGN letter was in response to a request for comment by the International Accounting Standards Board (IASB) and its U.S. counterpart, the Financial Accounting Standards Board (FASB) on a discussion paper on harmonization objectives. The IASB and the FASB have been working on harmonizing the two accounting systems since October 2002 and have set 2008 as the goal for finalizing the process.

Unlike the current IASB auditing framework, the discussion paper endorses a model more similar to U.S. standards, dropping a key shareowner safeguard embedded in U.K.-style standards, the ICGN noted. Rather than focusing audits on past transactions, the discussion paper calls for audits to focus on "decision-usefulness" that can affect company cash flows, the letter said.

"We are concerned that this emphasis on the ability to forecast the future does not fully capture the requirements of stewardship, which is concerned with monitoring past transactions and events," Mark Anson, the CEO of Hermes Pensions Management who chairs the ICGN, wrote in the Nov. 2 letter. (A Hermes affiliate is a part owner of ISS.)

"In many jurisdictions, financial statements provide significant input into the decisions we make as shareholders, by providing an account of past transactions and events and the current financial position of the business," the ICGN letter noted. "In de-emphasizing things that are particularly [relevant to shareholders' risks and rights], the standards setters could achieve the perverse effect of actually increasing the cost of capital."

The ICGN includes more than 400 institutional and private investors, corporations, and advisers from 38 countries with capital under management in excess of $10 trillion, according to its Web site. The ICGN letter also was signed by Claude Lamoureux, CEO of the Ontario Teachers' Pension Plan.

A copy of the IASB discussion paper, which was published in July, can be downloaded here.

 

Bob Jensen's threads on standard setting are at http://www.trinity.edu/rjensen//theory/00overview/theory01.htm#MethodsForSetting

Bob Jensen's threads on fair value accounting are at http://www.trinity.edu/rjensen//theory/00overview/theory01.htm#FairValue

Bob Jensen's threads on troubles in the big international accounting firms are at http://www.trinity.edu/rjensen/Fraud001.htm

"Booming Audit Firms Seek Shield From Suits," by David Reilly, The Wall Street Journal, by November 1, 2006; Page C1 ---
http://online.wsj.com/article/SB116235111161209823.html?mod=todays_us_money_and_investing

Business is booming at the world's biggest accounting firms, so their top lobbying priority may seem ironic: They want government protection from a big financial hit.

Revenues at the Big Four -- PricewaterhouseCoopers, Deloitte & Touche, Ernst & Young and KPMG -- have grown at a double-digit pace in recent years as audit fees soared. Regulatory overhauls enacted in the wake of accounting scandals earlier this decade have led to new work for firms. One of the biggest problems facing the Big Four these days is a lack of staff to meet the huge demand for services.

Yet the Big Four want to limit court damages that investors and others can seek from them for flawed audits of public companies. Without such a shield, the firms say, it's only a matter of time before one of them is felled by a massive court award.

Their argument is being championed by an influential group recently formed to study the competitiveness of U.S. financial markets with the encouragement of Treasury Secretary Henry Paulson. The group is expected to recommend in coming weeks that the government enact new protections for auditors. A panel set up within the powerful U.S. Chamber of Commerce is sounding a similar theme. In Europe, the European Commission is studying the issue and is likely to recommend limitations on the damages accounting firms can face.

How much risk the big firms actually face has been largely absent from the debate over auditor liability. Despite a slew of big-ticket lawsuits that emanated from corporate scandals earlier this decade, none of the firms suffered a fatal blow from those legal actions. The one big firm that folded, Arthur Andersen LLP in 2002, fell victim not to a lawsuit but to a criminal obstruction-of-justice conviction, later overturned on appeal.

"I don't see that auditors have a real need for any kind of special protections," said Bill Kelley, general counsel at the Retirement Systems of Alabama, which has sued accounting firms following corporate blowups. "Auditors need to be held to a high standard. Those are the outsiders we rely on. It's tough to have that responsibility, but that's what they're getting paid for."

Mr. Kelley and likeminded critics say it's also difficult to quantify the risk the firms face from a big court award. That's because the accounting firms are private partnerships that don't, in most cases, disclose their financial condition or results. So outsiders don't know how much capital the firms have, their level of profitability or even how much insurance they carry.

If anything, the risk from class-action lawsuits appears to be dwindling. The number of class actions that cite auditors as defendants declined to five last year from 14 in 2002, according to the Stanford Law School Securities Class Action Clearinghouse.

The bigger threat to firms has stemmed not from civil litigation, but from alleged criminal actions related to their conduct. In addition to the Arthur Andersen case, KPMG LLP suffered a near-death experience last year due to its sale of improper tax shelters; federal prosecutors ultimately decided not to indict the firm, a move that likely would have put it out of business.

The Andersen and KPMG cases have led some lawyers to claim that the Big Four are already seen by government as too big to fail. "The fact is that the government couldn't indict KPMG for policy reasons," said Sean Coffey, a partner at New York law firm Bernstein Litowitz Berger & Grossmann LLP, who has sued several accounting firms. "These folks are effectively immune to being put out of business and now they're trying to find ways to further inoculate themselves from accountability."

The firms also have shown they can weather pretty big hits. Over the past two years, KPMG has agreed to pay out nearly $700 million in fines and settlements related to criminal and civil actions. In 2000, Ernst & Young LLP settled for $335 million a shareholder suit related to its work for Cendant Corp.

Accounting firms argue the danger they face from civil litigation is real and that there are still many scandal-era actions that have yet to work their way through the courts. What is needed, the firms say, are litigation caps similar to those many states have enacted to protect doctors from malpractice suits.

The firms say special protection is warranted because they can be sued not just by the companies whose books they audit, but also by others, such as investors. These investors, the firms add, try to use auditors to recoup stock-market losses.

"The cost of our audits was never built for insuring the capital markets," said William G. Parrett, chief executive of Deloitte Touche Tohmatsu, the international arm of Deloitte & Touche. "I don't think we're saying we shouldn't have any liability, but it has to be in proportion to our participation in any problem."

The firms also say they can't get sufficient insurance because their liability is almost unlimited, encompassing in a worst-case scenario the total stock-market value of the companies they audit. So they are forced to settle lawsuits rather than risk a trial.

A study for the European Commission, released in September, said the total costs of judgments, settlements, legal fees and related expenses for the U.S. audit practices of the Big Four firms had risen to $1.3 billion in 2004, or 14.2% of revenue, up from 7.7% in 1999. In addition, according to a study by insurer Aon, there were 20 claims outstanding against U.S. auditors as of September 2005 where damages sought or estimated losses topped $1 billion. Accounting firms say they couldn't survive an award of that size.

Advocates of liability caps frame the issue around the broader debate over U.S. market competitiveness.

"I think the whole issue of liability is one of the major reasons why foreign companies aren't coming here" to list their stocks on U.S. exchanges, said Hal S. Scott, a Harvard Law School professor and a founding member of the Committee on Capital Markets Regulation, the group formed with Mr. Paulson's blessing to study market competitiveness. Mr. Scott added that while court awards can serve as a deterrent to shoddy audit work, "if we left this to the legal process, we might come up with the right amount of damages to deter bad behavior but have just two or three accounting firms" because one will have gone out of business.

Recognizing, though, that auditor liability overhaul might be a tough sell on Capitol Hill, the committee may suggest that the U.S. Securities and Exchange Commission come up with a solution, Mr. Scott said. "The SEC could modify their own rules regarding liability," he added. One idea under study: Allowing accounting firms to negotiate liability caps with clients, a practice now barred to preserve auditors' independence.

[Appeal for] "More Transparency for Audits," SoxFirst, August 2006 --- http://www.soxfirst.com/50226711/more_transparency_for_audits.php

For a profession that likes to think of itself as transparent, auditors might have some way to go. Particularly when it comes to companies revealing to the market why they have dismissed or changed an auditor.

According to risk researchers, Glass Lewis, it's one area that needs urgent attention. It's absolutely critical information for investors.

In their report Mum's the word, they point out that 1,430 publicly held companies changed their independent accounting firms last year including 77 companies that changed auditors at least twice. But in the vast majority of cases, we don't know why, because neither the companies nor the auditors disclosed the reasons.

"Perhaps it's our skeptical nature, but we suspect a lot of the companies that stayed mum changed auditors because of less virtuous reasons: to seek more favorable opinions, to flee from disagreements,to cut costs in a way that may diminish audit quality, or because their former auditors couldn't rely on them," says the report.

The report calls on the SEC to expand its list of required "reportable events" so that investors get more information about such matters as whether there had been difficulties conducting the audit and whether the auditor had advised the company about potential fraud.

Investors need nothing less from the profession that's required to watch over the companies that they, the investors, own.

A Sad Time for Corporate Reputations

"Question for Corporate America: Does Your Reputation Fall into the Liabilities Column on Your Balance Sheet?" PR Web, June 19, 2006 --- http://www.prweb.com/releases/2006/6/prweb399939.htm

In a survey conducted among 2,000 participants at the 2004 Annual Meeting of the World Economic Forum, more CEOs said that corporate reputation, not profitability, was their most important measure of success. Fortune Magazine calculates that a one-point change on its scale used to rank its most admired companies translates to a difference of $107 million to a company’s market value.

Lord Levene, Chairman of Lloyd’s of London, reported in a 2005 speech at the Philadelphia Club that loss of reputation is now viewed as the second most serious threat to an organization’s viability. (Business interruption is the first.)An Economist Intelligence Unit survey ranked reputational risk as the greatest potential threat to an organization's value. More than 30% of participating CEOs said that reputational risk represents the greatest potential threat to their company's market value. Of this same group of CEOs only 11% said that they had taken any action against the threat.

If these data are not sufficient to jolt companies into action, there is enough compelling data linking corporate reputation to corporate performance that should. Fortune Magazine, which has been publishing the results of its "America’s Most Admired Companies" survey for 20 years, calculates that a change of 1 point on its scale, either positively or negatively, affects a company's market value by an average of $107 million. The results of another study published in 2003 in Management Today, Britain's leading monthly business magazine, demonstrate a clear correlation between corporate reputation and equity return. Using existing data from Fortune’s surveys to construct portfolios of the most and least admired companies, the authors found that for the five years following Fortune’s publication of the results, the portfolios of the most admired companies had cumulative returns of 126% while those of the least admired had cumulative returns of 80%.

"While executives may choose to spend time analyzing these data and poking holes in research methodologies in order to dismiss reputation as a strategic priority," says Wallace, "the effort would simply provide another diversion from addressing the problem head-on. The fact that corporate America's sullied reputation has lead to such dramatic legislative change in the form of the Sarbannes-Oxley Act, and that it has become routine front-page news, is as telling as any data. No company wants bad press, but it may finally be what convinces American business that, left unmanaged, a company’s reputation can become a terminal liability."

Continued in article

Bob Jensen's threads on accounting for intangibles are at http://www.trinity.edu/rjensen//theory/00overview/theory01.htm#TheoryDisputes
 

Situational Ethics in Practice

October 12, 2006 message from Scott Bonacker [aecm@BONACKER.US]

It was really the second of these two articles that caught my eye. The point being, in any case, that teaching ethical behavior is not just an issue for accountancy.

10-04-2006 Security's Rotten Apples http://www.darkreading.com/document.asp?doc_id=105282 

"if you're working with at least two other IT/security professionals, and you're not breaking any rules, look around -- there's a good chance one of them is.

That's the net result of Dark Reading's "Security Scruples" reader survey, which tested the attitudes and ethics of some 648 IT and security pros over the last two weeks.

The survey, which asked IT people about their beliefs and behavior in both real and hypothetical security situations, suggests that about two thirds of them agree on the conventions for proper conduct -- and the other third might be doing anything from peeking at colleagues' personal data to actively stealing information from the company."

10-11-2006 Corporate Ethics are 'Situational' http://www.darkreading.com/document.asp?doc_id=107203 

"Officially, corporations never fail to report suspected security violations, never pay ransoms to hackers, and never allow employees to use company IT systems for personal reasons.

Unofficially, they do all of those things.

According to Dark Reading's "Security Scruples" survey, which concluded today, many enterprises operate differently in private than they say they do in public. And those differences cause some concerns for IT security professionals, whose jobs are on the line."

Scott Bonacker
Springfield, MO

Recall that the New York regulators had a long history of taking CPA licenses away only for DWI drunk driving convictions (which when you think about it probably has little to do with professional practice competency)

"NY Crackdown on Bad Accountants Addresses Long-Term Concern," AccountingWeb, July 17, 2006 --- http://www.accountingweb.com/cgi-bin/item.cgi?id=102351

New York State regulators’ new crackdown on the accounting profession addresses an issue that has been roiling in the Empire State ever since the Enron accounting scandal surfaced several years ago.

The New York State Board of Regents has revised the definition of "unprofessional conduct" for CPA's licensed by the state to include disciplinary actions taken by the Securities and Exchange Commission (SEC) and its Public Company Accounting Oversight Board (PCAOB), meaning that accountants or accounting firms disciplined by either of those bodies now can be subject to censure, reprimand and the revocation of their licenses.

The board also expanded the “unprofessional conduct” definition to include any settlement with those agencies where a CPA admits no wrongdoing but is still stripped of the right to practice the profession at a public company. “We wanted to be in position where if someone is licensed in this state is disciplined at the federal level that they're held accountable at the state level too," said Johanna Duncan-Poitier, deputy commissioner of the state Education Department's Office of Professions.

The new provision apparently resolves a disciplinary anomaly. Without the added state level regulatory teeth, accountants punished by the SEC for public company wrongdoing have been free to provide services to private companies and other organizations.

The need for the state to more tightly oversee CPAs and punish them for wrongdoing came to light in the Enron heyday of 2002 when “Crain’s New York Business” reported that out of New York State’s approximately 50,000 licensed accountants, only 16 were disciplined by the state in 2001, and only one was reprimanded on professional grounds.

The report sparked a call for tighter oversight that included cries from the profession itself. "Something is broken, and we need to fix it," New York State Society of CPAs Executive Director Lou Grumet was quoted as saying at the time. "I hope the low number of disciplinary actions shows that our members are perfect, but I believe the reality is that there are not enough resources to look at them.”

More recently, an Associated Press investigation found that the SEC had taken disciplinary action against more than 50 accountants in 2005 and 2006 for misconduct, “but that nearly half of them continue to hold valid state licenses to offer their services as certified public accountants.” Reportedly, none of the New York licensees disciplined by the SEC in 2005 and 2006 had been disciplined as of early June, though two disciplined by the PCAOB have been.

Some of the individuals disciplined by the SEC are now being investigated by New York regulators, Duncan-Poitier has confirmed. But she would not disclose any of the cases underway.

The public in New York may well welcome the additional regulatory muscle for another reason. The accounting profession has been under the media’s microscope in New York over the past year because of a spate of alleged accounting fraud by CPAs serving the public school district, which have included the theft of millions of dollars from a district in Long Island, N.Y.

Investors in Hedge Funds Do So at Their Own Peril

Hedge Funds Are Growing: Is This Good or Bad?
When the ratings agencies downgraded General Motors debt to junk status in early May, a chill shot through the $1 trillion hedge fund industry. How many of these secretive investment pools for the rich and sophisticated would be caught on the wrong side of a GM bond bet? In the end, the GM bond bomb was a dud. Hedge funds were not as exposed as many had thought. But the scare did help fuel the growing debate about hedge funds. Are they a benefit to the financial markets, or a menace? Should they be allowed to continue operating in their free-wheeling style, or should they be reined in by new requirements, such as a move to make them register as investment advisors with the Securities and Exchange Commission?
"Hedge Funds Are Growing: Is This Good or Bad?" Knowledge@wharton,  June 2005 --- http://knowledge.wharton.upenn.edu/index.cfm?fa=viewArticle&id=1225     

"Court Says S.E.C. Lacks Authority on Hedge Funds," by Floyd Norris, The New York Times, June 24, 2006 --- Click Here 

A federal appeals court ruled yesterday that the Securities and Exchange Commission lacks the authority to regulate hedge funds, dealing a possibly fatal blow to the commission's efforts to oversee a rapidly growing industry that now has $1.1 trillion in assets.

A three-judge panel of the United States Court of Appeals for the District of Columbia Circuit ruled unanimously that the commission exceeded its power by treating investors in a hedge fund as "clients" of the fund manager. The commission has authority over any manager with at least 15 clients, and it used that to require hedge fund managers to register.

The ruling, unless overturned on appeal, means that Congressional action would be required to grant the S.E.C. the authority to force hedge fund managers to register, or for the commission to impose any other rules on such funds.

The ruling does not leave such funds totally above the law since they are treated like any other investor in determining whether they violated securities laws. As a result, the decision will not affect an S.E.C. investigation into possible insider trading by a major hedge fund manager, Pequot Capital Management, which was disclosed in a New York Times article yesterday.

Christopher Cox, who became S.E.C. chairman after the rule was adopted, said the commission would review the issue, but stopped short of indicating that it would continue to seek authority over hedge funds.

"The S.E.C. takes seriously its responsibility to make rules in accordance with our governing laws," Mr. Cox said in a statement. "The court's finding, that despite the commission's investor protection objective its rule is arbitrary and in violation of law, requires that going forward we re-evaluate the agency's approach to hedge fund activity."

He said the commission would "use the court's decision as a spur to improvement in both our rule making process and the effectiveness of our programs to protect investors, maintain fair and orderly markets, and promote capital formation."

As hedge funds have grown, and as some have collapsed amid fraud or because they took excessive risks, pressures to regulate them have grown. But fund managers have protested that the vast majority have acted responsibly and should not be subjected to what James C. McCarroll, a lawyer with Reed Smith, a New York law firm, said yesterday were "regulatory overlays and burdens" approaching those faced by mutual funds.

The S.E.C. rule, adopted in December 2004 on a 3-to-2 vote, called for fund managers with more than $30 million in assets and at least 15 investors to register with the commission. Nearly 1,000 managers did so by the deadline of Feb. 1, 2006.

The S.E.C. rule exempted funds that imposed two-year lockups on investors' money, meaning the money could not be withdrawn for at least that long, leading a number of funds to impose such lockups. Some may choose to remove or ease those rules now.

Hedge funds, as the appeals court opinion written by Judge Arthur R. Randolph noted, "are notoriously difficult to define." But they generally are open only to wealthy investors and charge fees based on a percentage of the assets under management plus a portion of the profits.

The growth of hedge funds has made some managers incredibly wealthy, with incomes dwarfing even those of high-paid corporate chief executives. Alpha, a publication of Institutional Investor, reported that two hedge fund managers earned more than $1 billion each in 2005.

The pressure for more oversight of hedge funds grew after one fund, Long-Term Capital Management, almost collapsed in 1998. The Federal Reserve, fearful that such a collapse could cause systemic risk, encouraged Wall Street firms to mount a rescue, which they did.

The emergence of activist hedge funds, which sometimes act in concert with each other and can become the largest shareholders of some companies, has also increased calls for regulation, both here and in Europe. A German politician called such funds "locusts" that plundered German companies and then fired German workers. Some European governments have pushed for international regulation of such funds.

The decision to push for S.E.C. registration was made by Mr. Cox's immediate predecessor, William H. Donaldson. Mr. Donaldson argued that the funds had grown so large they could cause systemic risk to the financial markets, and that a gradual process of "retailization," through such trends as "fund of funds" that allow relatively small investments, had made it more important for regulators to have at least some knowledge of what was going on in the funds.

Bob Jensen's threads on hedge funds are under the H-Terms at http://www.trinity.edu/rjensen/acct5341/speakers/133glosf.htm#H-Terms

Bob Jensen's "Rotten to the Core" threads are at http://www.trinity.edu/rjensen/FraudRotten.htm

The Sad State of Professional Discipline in Public Accountancy

"SEC Accountant Fines Largely Go Unpaid," SmartPros, June 7, 2006 --- http://accounting.smartpros.com/x53399.xml

The Securities and Exchange Commission has taken disciplinary action against more than 50 accountants in 2005 and 2006 for misconduct in scandals big and small. But few have paid a dime to compensate shareholders for their varying levels of neglect or complicity.

It also turns out that nearly half of them continue to hold valid state licenses to hang out their shingles as certified public accountants, based on an examination of public records by The Associated Press.

So while the SEC has forbidden these CPAs from preparing, auditing or reviewing financial statements for a public company, they remain free to perform those very same services for private companies and other organizations that may be unaware of their professional misdeeds.

Some would say the accounting profession has taken its fair share of lumps, particularly with the abrupt annihilation of Arthur Andersen LLP and the jobs of thousands of auditors who had nothing to do with the firm's Enron Corp. account. Meantime, the big auditing firms are paying hundreds of millions of dollars in damages - without admitting or denying wrongdoing - to settle assorted charges of professional malpractice.

Individual penance is another matter, however, and here the accountants aren't being held so accountable.

Part of the trouble is that there doesn't appear to be an established system of communication by which the SEC automatically notifies state accounting regulators of federal disciplinary actions. In several instances, state accounting boards were unaware a licensee had been disciplined by the SEC until it was brought to their attention in the reporting for this column. The SEC says it refers all disciplinary actions to the relevant state boards, so the cause of any breakdowns in these communications is unclear.

Another obstacle may be that some state boards do not have ample resources to tackle the sudden swell of financial scandals. It's not as if, for example, the Texas State Board of Public Accountancy had ever before dealt with an accounting fraud as vast as that perpetrated at Houston-based Enron.

"We don't have the staff on board to manage the extra workload that the profession has been confronted with over the last few years," said William Treacy, executive director of the Texas board. "So we contracted with the attorney general's office to provide extra prosecutorial power."

Treacy said his office is usually notified of SEC actions concerning Texas-licensed CPAs, but the process isn't automatic.

With other states, communications from the SEC appear less certain. If nothing else, many boards rely upon license renewals to learn about SEC actions, but that only works if the applicants respond truthfully to questions about whether they've been disciplined by any federal or state agency. A spokeswoman for Georgia's board said one CPA recently disciplined by the SEC had renewed his license online without disclosing it.

Ransom Jones, CPA-Investigator for the Mississippi State Board of Public Accountancy, said most of his leads come from other accountants, media reports and annual registrations.

"The SEC doesn't necessarily notify the board," said Jones, whose agency revoked the licenses of key players in the scandal at Mississippi-based WorldCom.

Some state boards appear more vigilant than others in policing their membership. The boards in California and Ohio have punished most of their licensees who have been disciplined by the SEC since the start of 2005.

New York regulators haven't yet penalized any locals targeted by the SEC in that timeframe, though they have taken action against two disciplined by the SEC's new Public Company Accounting Oversight Board. It is conceivable that cases are underway but not yet disclosed, or that some individuals have been cleared despite the SEC's findings. A spokesman for the New York State Education Department said all SEC referrals are probed, but not all forms of misconduct are punishable under local statute. New rules now under consideration would strengthen those disciplinary powers, he said.

Meanwhile, although the SEC deserves credit for de-penciling those CPAs who've breached their duties as gatekeepers of financial integrity, barely any of those individuals have been asked to make amends financially.

No doubt, except for those elevated to CEO or CFO, most accountants are not paid as handsomely as the corporate elite. That said, partners from top accounting firms are were [sic] paid well enough to cough up more than the SEC has sought, which in most cases has been zero.

Earlier this year, in what the SEC crowed about as a landmark settlement, three partners for KPMG LLP agreed to pay a combined $400,000 in fines regarding a $1.2 billion fraud at Xerox Corp. One of those fined still holds his license in New York.

"The SEC has never sought serious money from errant CPAs," said David Nolte of Fulcrum Financial Inquiry LLP. "Unfortunately, the small fines in the Xerox case set a record of the amount paid, so everyone else has also gotten off easy."

It's not that the CPAs found culpable in scandals don't deserve a right to redemption, or just to earn a living. Most of the bans against practicing before the SEC are temporary, spanning anywhere from a year to 10 years.

But the presumed deterrent of SEC action is weakened if federal and state regulators don't work together on a consistent message so bad actors don't get a free pass at the local level.

"Some CPAs Escape State Disciplinary Action," AccountingWeb, June 20, 2006 ---
http://www.accountingweb.com/cgi-bin/item.cgi?id=102273

There have been more than 50 accountants sanctioned over 2005 and 2006 for professional misconduct and few of them have compensated shareholders for their complicity or neglect. The Associated Press reports that although sanctioned not to practice public accounting for between one and ten years by the SEC, these accountants still prepare, audit or review financial statements for public companies.

They also remain able to perform these services for private companies. While firms such as Arthur Andersen and others have paid huge sums in accounting damages, the individual accountants have escaped their professional penance, according to the Associated Press.

The disconnect seems to be an established communication system that would allow the SEC to advise state accounting boards of federal sanctions against rogue accountants. Another aspect of the disconnect is that state accountancy boards do not have staff to handle the number or reach of financial scandals such as Cendant, Enron or WorldCom.

Texas is one of many states facing this situation. License renewals are not a verifiable method of finding out about SEC sanctions unless without the accountant completing the questions truthfully. A spokesman for the Georgia board told the Associated Press that a CPA recently renewed his license online without disclosing his disciplinary action by the SEC.

William Treacy, executive director of the Texas State Board of Public Accountancy, told the Associated Press, “We don’t have the staff on board to manage the extra workload that the profession has been confronted over the last few years, so we contracted with the attorney general’s office to provide extra prosecutorial power.”

One of the problems and potential fixes to this situation may be to fine accountants. After a landmark SEC settlement in which three partners at KPMG agreed to pay a combined fine totaling $400,000 for their complicity in the $1.2 billion fraud at Xerox, the Associated Press reports that one of the partners still holds his license in New York.

David Nolte of Fulcrum Financial Inquiry told the Associated Press, “The SEC has never sought serious money from errant CPAs. Unfortunately, the small fines in the Xerox case set a record of the amount paid, so everyone else has gotten off easy.”

With the heavy investment in internal controls and procedures by CPA firms, the human element of accounting and auditing helps even large CPA firms fail to identify accounting problems. Members of an audit team can identify insufficient knowledge, misrepresentation of information, sloppy accounting or even simple misrepresentation of information but must be able to see the warning signs of other risky behavior. The CPA Journal suggests a 360-degree assessment of members on an audit team. As a structured, systematic way to collect information, evaluators include the person’s boss, peers, direct reports, and even clients.

Continued in article

Bob Jensen's threads on auditor fraud and incompetence are at http://www.trinity.edu/rjensen/FraudConclusion.htm#IncompetentAudits
 

House minority leader Nancy Pelosi has never been known as the brightest bulb in Congressional chandelier, but with her seniority she often is a difficult obstacle for Republicans. She faces a difficult challenge of representing the most liberal anti-business and anti-war district in the United States. Why then has she suddenly become the darling of the Editorial Page of The Wall Street Journal?

"Two Cheers for Nancy Pelosi," by Mallory Factor, The Wall Street Journal, March 18, 2006, Page A9 --- http://online.wsj.com/article/SB114264532108001981.html?mod=opinion&ojcontent=otep

Have America's entrepreneurs and corporate leaders found a new voice of regulatory sanity in, of all people, Nancy Pelosi? Apparently so, and that should be a wake-up call to Republicans -- because like everything else in the free market, the free enterprise agenda is up for grabs. In the recent "Innovation Agenda" that the House Democratic leader and her party unveiled, Ms. Pelosi acknowledges specifically the need to "ensure Sarbanes-Oxley requirements are not overly burdensome," and endorses reform. Meanwhile, the scourge of Wall Street, New York Attorney General Eliot Spitzer, is criticizing Sarbanes-Oxley's "unbelievable burden on small companies" and its possible role in "preventing some initial public offerings."

Ms. Pelosi and other Democrats have been quicker to recognize what many traditional champions of free enterprise have been slow to see: the law's disastrous consequences for our nation's ability to compete. Congress passed this law hastily in 2002 after the egregious accounting frauds at Enron and WorldCom. The intent was to hold publicly held companies and their executives more accountable and weed out bad actors; but that's not been the effect. Four years after passage, it is now evident that the costs of Sarbox clearly outweigh the benefits.

Consider first the costs. Recent estimates from the American Electronic Association, for example, show that U.S. companies are spending $35 billion annually simply to comply with the law as opposed to original federal estimates of $1.2 billion. A University of Nebraska study found that audit fees for Fortune 1000 companies, on average, increased a staggering 103% from 2003 to 2004. The costs of being a U.S. public company are now more than triple what they were before the law passed, according to a study conducted by the Milwaukee-based law firm of Foley & Lardner. Some smaller firms report that they are spending 300% more on Sarbox compliance than on health care for their employees.

Based on a growing body of theoretical and empirical research, the SEC's Advisory Committee on Smaller Public Companies concluded that Sarbox places a disproportionate compliance burden on small public companies, making it more difficult for them to compete with foreign companies and to a lesser extent with larger U.S. companies. Consider the survey by the American Electronics Association, which found that companies with sales of $100 million and under are spending 2.6% of their revenues on Sarbox compliance -- enough to tip many of them from profitability into unprofitability. This makes it something of a challenge for these companies to innovate, compete or grow -- or even survive.

As a result of these burdensome costs, enterprises are deciding not to go public, or else are opting to back out of our capital markets. Explaining his company's absorption into privately held Koch Industries, Peter Correll, the CEO of Georgia-Pacific, said, "There is a lot of time spent by top management on things that are not value-adding, but are simply bureaucratic and are required by a raft of regulation." In fact, the Foley & Lardner study found that 20% of public companies are considering going private just to avoid Sarbox compliance. It's no wonder, then, that the London Stock Exchange -- eager to exploit a competitive advantage -- now promotes itself by reminding companies that by listing on the LSE they are not subject to Sarbox.

Beyond the direct cost of compliance to individual companies, a recent University of Rochester study concluded that the total effect of the law has reduced the stock value of American companies by $1.4 trillion. That is $1.4 trillion that could be invested in infrastructure improvements, jobs, innovative technologies or research and development. As Sun Microsystems CEO Scott McNealy says, Sarbanes-Oxley throws "buckets of sand into the gears of the market economy."

The true beneficiaries of Sarbox are the nation's large auditing firms, which now maintain a regulatory oligarchy composed of a handful of entrenched services corporations. They will continue to champion Sarbox, since it provides a guaranteed market for their services. Surely this law was not intended by its authors to become a full employment act for the same auditing industry which was implicated in the original malfeasance of four or five years ago.

Continued in editorial

S.E.C. to Ease Auditing Standards for Small Publicly Held Companies
The Securities and Exchange Commission will begin the process of easing auditing standards for thousands of smaller public companies this Wednesday when it proposes rules under the most contentious provision of the Sarbanes-Oxley Act. The relaxed standards represent a compromise, giving a qualified victory for businesses, which had considered any regulation burdensome, and for the auditing firms, which had benefited from the imposition of stringent requirements on their clients.
Stephen Labaton, "S.E.C. to Ease Auditing Standards for Small Publicly Held Companies," The New York Times, December 11, 2006 --- Click Here

June 6, 2006 message from Ganesh M. Pandit [profgmp@HOTMAIL.COM]

An  article published in the March 2006 issue of the CPA Journal says "Accounting did not cause the recent corporate scandals such as Enron and WorldCom. Unreliable financial statements were the results of management decisions, fraudulent or otherwise. To blame management's misdeeds on fraudulent financial statements casts accountants as the scapegoats and misses the real issue....". The article can be accessed at http://www.nysscpa.org/cpajournal/2006/306/essentials/p48.htm 

Any thoughts from anybody??

Ganesh M. Pandit
Adelphi University

June 6, 2006 reply from Bob Jensen

Shame on the Lin and Wu!

Enron's Chief Accounting Officer, Rick Causey, now sits in prison after having admitted to falsifying accounts. He refused to testify in the Lay/Skilling trial unless granted immunity from other prosecution.

Other Enron executives, including some accountants, have confessed to accounting fraud.

Accounting fraud committed by accountants purportedly because their bosses ordered them to knowingly participate in the fraud does not make the fraud non-accounting fraud no matter what the NYSSCPA Society tries to tell us.

The NYSSCPA Society published this Lin and Wu article. Recall that the NYSSCPA Society only took CPA licenses away from CPAs convicted of drunk driving and overlooked CPA fraud for decades in New York. I don't place much stock in this NYSSCPA Society defense of accountants. I don't find the article that you mention even worth citing. The authors did not do their homework on the Enron or Worldcom scandals.

When Andersen auditor Carl Bass sniffed out both charge-off and derivatives accounting fraud, his boss David Duncan had him removed from the Enron audit.

The Worldcom fraud was Accounting 101 where over $1 billion in expenses were knowingly capitalized by the CFO and top accounting executives. The top accountant mainly involved confessed that he knew what he did was against the law but played along because of his need for the large paycheck. Only when Worldcom internal auditor Cynthia Cooper finally figured out what was going on and refused to play along was this enormous accounting fraud brought to light.

These were huge ACCOUNTANT frauds contrary to what the Lin and Wu would like to make you believe with a whitewash article that should be beneath the professional standards of a CPA society. CPAs are under tremendous pressure to lobby on behalf of clients to water down Section 404 of SOX. The NYSSCPA is simply playing along with defending accountants who knowingly committed felonies. Now if they also had DWI convictions they'd be in bigger trouble with the NYSSCPA Society.

Bob Jensen

June 6, 2006 reply from Ganesh M. Pandit [profgmp@HOTMAIL.COM]

I don't think that this article is trying establish that this is not an accounting fraud...regardless of the title of the article. It is only saying that there were several parties in addition to the accountants who helped this fraud! :)

Ganesh

June 6, 2006 reply from Roger Collins [rcollins@TRU.CA]

Ganesh,

Let's think about this a minute...

It must be obvious from all the media reports that there were "parties in addition to the accountants". Lay was not an accountant; Skilling was not an accountant; Fastow never qualified as a CPA. So, if the Lin & Wu paper is merely stating the obvious, why publish it?

The only obvious answer is that the paper was approved for publication, not as a professional, but a political, statement. As Bob says,

"CPAs are under > tremendous pressure to lobby on behalf of clients to water down Section > 404 of SOX. The NYSSCPA is simply playing along with these clients and > their CPAs."

Think for a moment about how articles are read and interpreted. Most academic articles are published in so-called "academic" journals - to be read by other academics and thereafter consigned to the dust of history. A few establish new theories or lines of enquiry; rather more either mine an already existing line of enquiry or justify themselves in other ways such as maintaining or establishing academic reputations. Dr Johnson famously wrote "No man but a fool ever wrote, except for money" - and the money doesn't have to be a direct flow of cash. There are a few selfless souls who find academic accounting an end in itself, but they are thin on the ground.

Most professional articles are read far more widely. But they are often skimmed or "headlined", with summaries - or less - tossed around for any manner of reasons. Whether it was their intention or not, what L and W have done is to provide ammunition in the defence of a group - accountants - who, as the NYSSCPA and other professional groups, seek to deflect responsibility and accountability when they should be engaging in a much more profound examination of accounting policies, procedures and ethics. Articles such as that by L &W are harvested for sound bites by the profession's apologists and replayed ad infinitum for the benefit of any politician / lobbyist who will lend an ear.And, as Bob says, that comes down to yet more pressure to roll back the one major advance in accountability the accounting world has experienced in a very long time. All in all, its NOT "A Good Thing".

Regards,

Roger

Roger Collins
TRU School of Business PS For anyone curious about the previously-mentioned Mandy Rice-Davis... http://en.wikipedia.org/wiki/Mandy_Rice-Davies

June 6, 2006 added reply from Roger Collins [rcollins@TRU.CA]

After my last note, I came across this article, reporting on a piece of acdemic research that's in stark contrast to the W & L article...

http://money.cnn.com/2006/05/26/magazines/fortune/colvin_fortune_0612/index.htm 

A quote.... "Then came Sarbanes-Oxley, which required that option grants be reported within two business days. A new paper by Lie and Randall Heron of Indiana University, still unpublished, finds that evidence of backdating virtually disappears after Aug. 29, 2002, when the requirement took effect."

(My apologies if others have posted this previously).

Regards,

Roger

Roger Collins
TRU School of Business

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

Bob Jensen's threads on the Enron, Worldcom, and Andersen meltdowns can be found at http://www.trinity.edu/rjensen/FraudEnron.htm

"Enron’s Lasting Influence," AccountingWeb, January 10, 2006 ---
http://www.accountingweb.com/cgi-bin/item.cgi?id=101647

With the former Enron executives finally coming to trial, we are reminded again of the long shadow cast by the implosion of the company that helped enact the Sarbanes-Oxley (SOX) Act of 2002. Section 404 has added teeth to SOX, making regulation more expensive and staff intensive and the Public Company Accounting Oversight Board (PCAOB) has been created to aid in the governance and enforcement of the accounting industry. Audit committees have attained more important positions in corporate structures and are more attuned to avoid the conflicts of being both auditor and consultant for the same company. At the same time, with the collapse of Arthur Andersen, the consolidation of the Big Five to the Big Four now have four accounting firms doing the work for more than 90 percent of publicly traded companies, according to the New York Times.

“We certainly have seen some improvements in governance, but we’ve also seen some areas of no improvement, and some areas where things have gone backwards,” said Lynn E. Turner, speaking to the New York Times. Turner is the former chief accountant at the Securities and Exchange Commission (SEC) and now managing director of research at Glass, Lewis & Company.

The outright accounting scandals of WorldCom, Tyco, and Adelphia have now morphed into companies making financial restatements. Glass, Lewis & Company reports that earnings restatements numbered 1,031 through the end of October 2005, compared with 650 for 2004 and 270 in 2001, according to the New York Times. John C. Coffee, speaking in the Los Angeles Times, said the restatements were not necessarily evidence of fraud but shows the tighter focus of accountants.

Also, more than 1,250 public companies, out of around 15,000 in total, reported material weaknesses in their internal corporate controls in October 2005. Some 232 other companies reported less serious, but significant deficiencies in their internal controls, according to the New York Times.

In contrast, a new study shows that the number of securities class-action suites has come down 17 percent in 2005. The 176 filed in 2005 is the lowest since 1997, according to Cornerstone Research and Stanford Law School. 1998 saw 239 suites, the highest number in recent years, according to the Los Angeles Times.

Christopher Cox, chairman of the SEC, said in a late December interview with the New York Times, that he agreed that more should be done, disclosing his intention to lead a commission effort to rewrite rules forcing companies to provide more financial details concerning executive pay.

Tighter accounting and disclosure rules enacted to enhance the transparency of financial information have lead to an industry-lead backlash. Cox said to the New York Times that it “would be a mistake” to retract major provisions of SOX.

“The shocks were so big that no director could miss the lesson and if they did miss somehow, the significant changes in the law made it absolutely certain that they are now more focused,” Cox added. “With just a few years of Sarbanes-Oxley under their belts, most companies are begrudgingly admitting that the exercise is producing benefits.”

SOX has sincere proponents though, institutional and pension investor groups being the most vocal. Alan G. Hevesi, New York comptroller of one of the nation’s largest institutional investors, has been leading the effort to increase corporate accountability. Speaking with the New York Times, Hevesi said, “We’ve had some successes in corporate governance reform. In other words – such as giving a greater voice to shareholders to elect independent directors and curbing excessive executive compensation – we haven’t been as successful. I worry about whether the necessary reforms have really been institutionalized.”

Executives say that restatements are healthy signs of change according to the New York Times although, “The general impression of the public is that accounting rules are black and white. They are often anything but that, and in many instances the changes in earnings came after new interpretations by the chief accountant of the S.E.C.," said Steve Odland, Office Depot’s CEO and head of a corporate governance task force at the Business Roundtable.

Accounting scandals are more often settled with the SEC or actions filed by the agency now. For example, AcAfee, the Internet security company, has agreed to settle charges made by the SEC that they inflated revenues by some $622 million between 1998 and 2000. Their penalty will be $50 million. The settlement is awaiting court approval.

The SEC filed a civil lawsuit against six former executives then employed by an unnamed transfer-agent unit of Putnam Investments last week. They allegedly defrauded mutual funds and clients out of some $4 million in 2001. Also the judge has ruled that SEC testimony will be allowed into the trials of former Enron executives Jeffrey Skilling and Kenneth Lay.

What are some of the main lessons learned from the Enron scandal? 
I especially like "Suggestions for Reform" listed at http://www.citizenworks.org/corp/reforms.php

A pretty good summary of lessons learned is provided at http://www.law.northwestern.edu/professionaled/documents/Ruder_Lessons_Enron.pdf

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

Bob Jensen's threads on the Enron/Andersen scandals are at http://www.trinity.edu/rjensen/FraudEnron.htm

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

"Combating Corporate Fraud," AccountingWeb, January 13, 2006 ---
http://www.accountingweb.com/cgi-bin/item.cgi?id=101663

The number of companies around the world that reported incidents of fraud increased 22 percent in the last two years, according to the 2005 biennial survey by PricewaterhouseCoopers (PwC), which interviewed more than 3,000 corporate officers in 34 countries. In England, a recent Ernst & Young survey of the Times Top 1000 indicated the average cost of each fraud exceeded $200,000. But fraud is not the only problem. There's also misconduct, unethical behavior, lying, falsification of records, sexual harassment, and drug and alcohol abuse.

PwC found that “accidental” ways of detecting fraud, such as calls to hotlines or tips from whistleblowers, accounted for more than a third of the cases. Internal audits were responsible for detecting fraud about 26 percent of the time.

Steven Skalak, Global Investigations Leader at PwC, told Reuters: "I think the investment in control systems is paying off and detecting more crime." The study found that companies with a larger number of controls could better determine the full impact of the fraud, uncovering three times as many losses as companies with fewer controls.

Many of the new and increased controls were generated through the passage of The Sarbanes-Oxley (SOX) Act of 2002, which made having confidential, anonymous reporting mechanisms a legal requirement for any publicly traded company. But private, government and non-profit organizations would be well advised to also create and implement this important tool.

While executives get the headlines, 43 percent of surveyed people admit to having engaged in at least one unethical act in the workplace in the last year, and 75 percent observed such an act and did nothing about it. Not spoken to the employee in question, not reported it, nothing. As much as we do not like to admit it, theft, fraud and malfeasance are common occurrences in companies. Unfortunately these practices exist in every level of the organization and irrespective of size or sector. Non-profits are stolen from in equal measure.

The Association of Certified Fraud Examiners 2002 Report to the Nation indicates, "the most common method for detecting occupational fraud is by a tip from an employee, customer, vendor or anonymous source." It additionally comments, "the presence of an anonymous reporting mechanism facilitates the reporting of wrongdoing and seems to have a recognizable effect in limiting fraud and losses."

The report concludes, "organizations with hotlines can cut their fraud losses by approximately 50 percent per scheme." To be effective, a confidential, anonymous reporting mechanism must be operated by an independent, third party. Employees are understandably hesitant and reluctant to report another employee. There is not only the fear of retaliation; there is the fear of retribution and of being ostracized by co-workers. In fact, in an independent survey, 54 percent gave this as the main reason for their silence.

There is also a concern if the incident involves management, or the person required to take the report or initiate the investigation. Employees must be confident in knowing they can report an incident effectively, confidentially and anonymously. Furthermore, statistics prove that an internal hotline or reporting mechanism is rarely perceived as truly anonymous.

You can become aware of and build upon the positive aspects of employee relations while proactively addressing and heading off potentially negative issues with Ethical Advocate’s confidential, anonymous reporting mechanisms and feedback system.

Confidential, anonymous reporting mechanisms serves as an early warning system, enabling organizations to react quickly to investigate issues, and often resolve problems prior to increased malfeasance, costly stealing, litigation, or negative publicity. Spending a few dollars early on can save untold dollars and valuable time. It also creates a culture of ethical behavior that over time will diminish the prospects of these actions.

When installed properly, confidential, anonymous reporting mechanisms can uncover a variety of information that can improve processes, resolve issues, and prevent catastrophic financial losses. Like a computer network and a website, an employee hotline was once just a good idea that top companies had adopted. Now it's a mandatory part of doing business.

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

Bob Jensen's threads on the importance of whistle blowing are at http://www.trinity.edu/rjensen/FraudConclusion.htm#WhistleBlowing

Bob Jensen's PowerPoint files on fraud are

PwC 2005 Global Annual Review

January 25, 2006 message from inman.and.wyer@us.pwc.com

We'd like to make the Annual Review available to you, so that you may explore the contents in an interactive manner via the link below.

http://www.pwc.com/2005GlobalAnnualReview 

PricewaterhouseCoopers Global Economic Crime Survey 2005

The threat of fraud from apparently simple cases of bribery to complex financial misrepresentation is more prominent than ever on the agendas of company directors and financial regulators. PwC's third biennial Economic Crime Survey is based on interviews with more than 3,600 senior executives in 34 countries, and reveals their experiences with fraud, its causes and losses, their responses and recovery actions and the effectiveness of fraud prevention measures. Please click to the link below to access the full survey.

http://www.pwc.com/EconomicCrimeSurvey 

Protecting International Trade

How can we reduce the risk that terrorists will exploit legitimate trade to attack the United States? One answer is described in PwC's "Cargo Security White Paper." It provides an example of the application of internal control processes to increase protection and expedite cargo. Please click to the link below to access the white paper.

http://www.pwc.com/cargosecuritycontrols 

PwC on Fortune "100 Best Companies to Work For"

As we communicated to you in the past, we have placed a significant focus on our people initiatives. As a result of these efforts, we have seen a substantial reduction in turnover; and as external validation of our focus we were pleased to hear the recent announcement that PwC is on the Fortune "100 Best Companies to Work For" in 2006. Our emphasis on the development and retention of our people continues to be a top priority for us.

As always we welcome your feedback and appreciate hearing from you on how PwC can best support you as faculty members.

Regards,

Brent Inman and Jean Wyer

Sarbanes-Oxley:  What is too much of a seemingly good thing?

"Class-Action Sarbox," The Wall Street Journal,  January 7, 2006; Page A6 --- http://online.wsj.com/article/SB113659722018040446.html?mod=opinion&ojcontent=otep 

At first glance, the study from Stanford University and Cornerstone Research seems to be good news, noting that the number of class-action suits filed in 2005 dropped to 176 from 213 in 2004 -- a 17% decrease. Good-governance types are claiming this decline is a direct result of the 2002 Sarbanes-Oxley legislation working as intended, keeping companies on the straight and narrow.

Yet as any first-year Wall Street analyst knows, this minor legal reprieve is better attributed to last year's relatively stable stock market. Class-action suits arise out of booms and busts in equity markets: As share prices dive, plaintiffs' lawyers swarm. Yet with last year's stock market less volatile than at any point since 1996, the "strike suit" pickings were lean.

So what then accounts for those 176 suits? Try . . . Sarbanes-Oxley. It appears the tort bar is now using the law's strict financial-reporting requirements as its latest excuse to sue. A whopping 89% of the suits alleged misrepresentations in financial documents, while 82% claimed false forward-looking statements. Lawyers have certainly used financial documents as a reason to sue in the past, but this year's notable uptick in the number of suits filed that cite this cause of action suggests that the tort bar has found a whole new line of business.

The real news here is that lawyers managed to drum up so many results-related suits in a year when the stock market was stable and corporate earnings were strong. Just wait for the next economic downturn, when class-action lawyers will be able to exploit Sarbox's new "internal controls" documentation as a roadmap. Our guess is that we have only begun to discover the ways in which Sarbox will be a trial-bar bonanza.

Continued in article

Jensen Comments
A useful reference site from Cornerstone is at http://www.cornerstone.com/fram_res.html
A Stanford University Press Release is at http://securities.stanford.edu/scac_press/20060103_CR_SCAC.pdf
The Stanford University Law School Class Action Clearinghouse is at http://securities.stanford.edu/

March 31, 2006 message from Richard Newmark [richard.newmark@PHDUH.COM]

I think this transcript is very informative about Sox and 404. It includes cost figures for compliance for different size companies. It notes that despite the high cost, more small companies have gone public after Sox went into effect. It also discusses the pros and cons of some of the alternatives being discussed for small companies.

http://www.exchange-handbook.co.uk/news_story.cfm?id=58462 

Rick
Richard Newmark

Sarbanes-Oxley (SOX) Sites
From Smart Stops on the Web, Journal of Accountancy, February 2006 --- http://www.aicpa.org/pubs/jofa/feb2006/news_web.htm

SOX/B&I SITES

Brush Up on Compliance www.aicpa.org/sarbanes/index.asp CPAs and compliance officers can find background documentation, guidance and tools for implementing the Sarbanes-Oxley Act of 2002 here. Looking for related CPE credit? Follow the link to the CPA2Biz.com store for a CD-ROM webcast. Or read the full text of the act and get a brief history of the regulations. Voice Your Opinion www.sarbanes-oxley-forum.com This e-portal offers visitors who register for free the opportunity to share their experiences of complying with Sarbanes-Oxley in its discussion forum; topics include audit and IT issues, conferences and training and control methodologies. Look up the portal’s latest poll results—or vote yourself—on which stage your organization has reached with respect to Sarbanes-Oxley compliance. Time to Take Control www.fei.org/advocacy/internal_controls.cfm CPAs and internal audit controllers will find a full menu of links to discussions, surveys, trends and white papers on Sarbanes-Oxley at this Financial Executives International Web spot. In addition to the full text of the act, you can find SEC and PCAOB guidance and summaries of section-404-related laws. Check out the results of Pricewaterhouse- Coopers’ Barometer Surveys on the impact of Sarbanes-Oxley on private companies and not-for-profits. For (Internal) Control Freaks www.cfoc.gov Managers, come to the Chief Financial Officer’s Council Web site to get the implementation guide for the Office of Management and Budget (OMB) Circular A-123 on your responsibilities for internal control over financial reporting. The guide comes with a detailed flowchart outlining a five-step assessment process and numerous exhibits, including one for the money spent on financial reporting activities. In IT We Trust www.itrb.gov The Information Technology Resources Board (ITRB) e-stop may be meant for employees using computer systems in federal government agencies, but all IT professionals can benefit from some of the content in the Published Reports section. Titles of note include “A Balanced Approach to Managing Risk in an Unfriendly World: An Executive’s Guide.”

 

Federal Reserve Chairman Alan Greenspan defended the Sarbanes-Oxley Act
Federal Reserve Chairman Alan Greenspan defended the Sarbanes-Oxley Act that Congress passed after a series of corporate accounting scandals, saying he is surprised that a law enacted so "rapidly" has "functioned as well as it has." Delivering a commencement address at the University of Pennsylvania's Wharton School yesterday, Mr. Greenspan said the 2002 law "importantly reinforced the principle that ... corporate managers should be working on behalf of shareholders to allocate business resources to their optimum use."
David Wessel, "Corporate Overhauls Are Proving To Be Effective, Greenspan Says," The Wall Street Journal, May 16, 2005; Page C3 --- http://online.wsj.com/article/0,,SB111616543499633916,00.html?mod=todays_us_money_and_investing

This is somewhat contrary to the praises being sung by CEOs of auditing firms

From Jim Mahar's Blog on August 30, 2005 --- http://financeprofessorblog.blogspot.com/

Sarbanes-Oxley after Three Years by Larry Ribstein

SSRN-Sarbanes-Oxley after Three Years by Larry Ribstein:

I am sure many of you have been wondering whether Sarbanes-Oxley has been successful or not. I know that I have been! Unfortunately, it is a very difficult thing to test. While the costs are relatively easy to measure, the benefits are not. Moreover, even like any regulation, the passage is anticipated and thus normal event studies get muddied.

So with that in mind (and a good dictionary in hand) I present to you Larry Ribstein's look at the Sarbanes-Oxley Act after three years.

Ribstein presents a very interesting history (why and how it came about) and summary (what it contains) of SOX. He then reviews the literature on the Act. This literature review can be summarized with the following quote:

"The finance studies on the effect of SOX have been accompanied by data on the costs of SOX that have fueled mounting doubt about the Act's cost-effectiveness." Ribstein's conclusion stems from this literature review:

"In general, the costs have been significant and the benefits elusive." Overall the paper makes several good points, and concludes with his recommendations for future legislation, however, I was left wanting more empirical evidence but I guess that will have to wait.

However, it was a good read and the history/summary section would be great for class use!

Cite: Ribstein, Larry E., "Sarbanes-Oxley after Three Years" (June 20, 2005). U Illinois Law & Economics Research Paper No. LE05-016. http://ssrn.com/abstract=746884 

BTW Jim's am not kidding about needing a good dictionary. ;)

Sarbanes Oxley Blues
What the business world now calls SOX is a law passed that forces auditing firms to provide better audits at a substantially increased cost to their clients.  We now have a new song that is not exactly a celebration of SOX.

From: Mike Kennelley [mailto:MKennell@jbu.edu]
Sent: Tuesday, March 01, 2005 8:24 AM
To: escribne@nmsu.edu
Subject: Sarbanes-Oxley Blues

If you haven't heard this one, turn on those speakers and enjoy . . . 

http://www.headwatersmb.com/content/audio_02.html

It appears SOX is here to stay, but there may be new designs almost every year

Jonathan D. Glater, "Here It Comes: The Sarbanes-Oxley Backlash," The New York Times, April 17, 2005 --- http://www.nytimes.com/2005/04/17/business/yourmoney/17sox.html

For corporate America, it is always a good time to lobby - even when the public image of business is increasingly associated with executive perp walks.

Last week, business representatives gathered in Washington at an all-day roundtable discussion held by federal regulators and complained about the cost of complying with a provision of the Sarbanes-Oxley corporate reform law. Not one business leader asked to repeal the law, which was passed in 2002 after a wave of financial scandals, or to gut it. Nearly every executive, however, lamented the costs of compliance

The criticism is striking, given that it comes against a backdrop of continuing revelations of potential fraud, criminal prosecution of fraud and convictions on fraud charges. Bernard J. Ebbers, the former chief executive of WorldCom, is awaiting sentencing after being convicted last month of fraud, conspiracy and filing false reports. Trials of former Enron executives are set to begin this week. Arthur Andersen, audit firm to both WorldCom and Enron, is still fighting to save its reputation and its few remaining assets in a lawsuit brought by WorldCom shareholders.

"There've been so many companies that have gotten in trouble, none of them want to come out now and say we oppose" the law, said Lynn E. Turner, a former chief accountant at the Securities and Exchange Commission who now works at Glass, Lewis & Company, an investment research firm in San Francisco. "It just leaves people with a bad feeling about that company."

He added that the last person whom he had heard was bashing Sarbanes-Oxley was Maurice R. Greenberg of the American International Group, who resigned as chief executive last month amid a review of the company's accounting and who invoked the Fifth Amendment when being interviewed by investigators last week.

"I don't think you're going to see that anymore," Mr. Turner said of executives' campaigning against Sarbanes-Oxley.

Instead, executives are pushing for what they describe as specific changes in the implementation of the law, while singing its praises in general terms.

"There is no question that, broadly speaking, Sarbanes-Oxley was necessary," said John A. Thain, chief executive of the New York Stock Exchange, in remarks echoed by others at the roundtable.

Nick S. Cyprus, controller and chief accounting officer for the Interpublic Group of Companies, was even more specific, praising a provision of the law that has become a particular target for many critics. "I'm a big advocate of 404," he said, referring to Section 404 of the law, "and I would not make any changes at this time."

Section 404 requires companies and their auditors to assess the companies' internal controls, which are the practices or systems for keeping records and preventing abuse or fraud. Something as simple as requiring two people to sign a company check, for example, is one type of internal control.

Of the 2,500 companies that filed internal controls reports with the Securities and Exchange Commission by the end of March, about 8 percent, or 200, found material weaknesses, the agency's chairman, William H. Donaldson, said at the roundtable. That exceeds the 5.6 percent rate that Compliance Week magazine found in a review of the first 1,457 companies to report.

Executives at the roundtable consistently said that complying with Section 404 has been more expensive than they had anticipated, and they questioned whether the benefit - which no one has been able to quantify - is worth the cost.

There are, perhaps unsurprisingly, several studies of the cost of compliance from various business groups. Financial Executives International, a networking and advocacy organization, said last month that a survey of 217 publicly traded companies showed they had spent $4.36 million, on average, to comply with Section 404.

A different survey, of 90 clients of the Big Four accounting firms - Deloitte Touche Tohmatsu, Ernst & Young, KPMG and PricewaterhouseCoopers - found that the companies spent an average of $7.8 million on compliance. That was about 0.10 percent of their revenue, and less than the $9.8 million paid, on average, to C.E.O.'s at 179 companies whose annual filings were surveyed earlier this month in Sunday Business.

Continued in the article

Pull your SOX up boss (remember Marlon Brando in Teahouse of the August Moon)
More than 500 public companies have reported deficiencies with their internal accounting controls under a controversial new federal rule -- a figure sure to feed the continuing debate about the cost and usefulness of recent efforts to strengthen corporate governance.  To backers, the volume of disclosures demonstrates that the new rule, part of the 2002 Sarbanes-Oxley corporate-accountability law, is pushing a lot of U.S. companies into line. But business groups complain that it's costing them a lot of money and effort to turn up deficiencies that in most cases are inconsequential.
Deborah Solomon, "Accounting Rule Exposes Problems But Draws Complaints About Costs," The Wall Street Journal,  March 2, 2005; Page A1 --- http://online.wsj.com/article/0,,SB110971840422767575,00.html?mod=home_whats_news_us 
Bob Jensen's threads on reforms are at http://www.trinity.edu/rjensen/FraudProposedReforms.htm 

Holy Sox Audit Man:  Those two little paragraphs in Section 404 and so much confusion
"Living With Sarbanes-Oxley:  How companies are coping in the new era of corporate governance," by Diya gullapalli, The Wall Street Journal, October 17, 2005; Page R1 ---
http://online.wsj.com/article/SB112922100637567825.html?mod=todays_us_the_journal_report

The centerpiece of Sarbanes-Oxley is internal controls: the checks and balances that make sure public companies record assets, liabilities and other items accurately on financial statements. Under Sarbanes-Oxley, companies must make sure their controls are sound, then have an auditor sign off on them.

One of the biggest problems companies had with compliance last year was the constant creation of new rules and standards by regulators who were still in the midst of translating the legislation into regulations. Section 404 of Sarbanes-Oxley, which lays out internal-control rules, is only two paragraphs long; it simply states that company management and auditors must certify the soundness of internal controls in annual reports. The newly created Public Company Accounting Oversight Board was assigned to help write up specific guidelines -- which meant companies had to start assessing their controls while the rules were still being created.

And companies couldn't turn to their auditors for guidance. Under the regulators' guidelines, auditors can't help companies design or implement their controls, because the auditors must eventually sign off on the companies' work. Helping the companies might compromise the auditors' role as independent observers. Some auditors, wary of violating rules, went even further and refused to offer advice on a host of other complex accounting matters -- making things even more confusing for companies.

The result: escalating tension. Foley & Lardner's report, for example, quotes corporate executives as saying that internal-control reporting "created an adverse relationship with auditors," in part because executives felt like they were paying auditors for advice and then not getting it. The rising price tag seemed to make things worse: One boss cited in the report said that auditors' higher fees meant the auditors "now drive a Mercedes instead of a Buick."

Continued in article

As part of an ongoing effort to improve ethical standards for tax professionals and to curb abusive tax avoidance transactions, the Treasury Department and the Internal Revenue Service have issued final regulations amending Treasury Department Circular 230.  “The playing field for tax advisors has changed with these standards for tax opinions, the new penalties that Congress recently enacted and other steps the IRS has taken to detect and deter abusive transactions,” said Namorato. "Most professionals share our concern about the egregious behavior of some of their colleagues and we appreciate the efforts of responsible practitioners to promote ethical practice. We are taking steps to ensure that all practitioners live up to their professional obligations.”
AccounitngWeb, December 22, 2004 --- http://www.accountingweb.com/item/100245 
New Tax Guide Available from the IRS --- http://www.irs.gov/newsroom/article/0,,id=131175,00.html 
Bob Jensen's tax helpers are at http://www.trinity.edu/rjensen/bookbob1.htm#010304Taxation 

Former Ernst & Young Tax Advisors:  Caught in the Middle of a Post-Sarbanes Client Tug-a-War
Carolyn Campbell says she decided it was time to leave accounting firm Ernst & Young when she realized she would have to build a new client base largely from scratch if she stayed.  Ms. Campbell, 35 years old, is an accountant whose specialty is advising large companies on local and state taxes. For most of her career, the Big Four firm's audit clients supplied the bulk of her work. But those jobs are harder to come by. Amid concerns of conflicts of interest, more public companies are cutting back on giving other, lucrative "nonauditing" assignments to their independent auditors amid concerns of conflicts of interest. That means less work for consultants employed by Big Four firms. In some cases, Ms. Campbell says, Ernst told her that longtime audit clients were off-limits ... So in October Ms. Campbell, an 11-year Ernst veteran, left her position in Houston as a senior tax manager to work for Alvarez & Marsal LLC, a consulting firm that doesn't do audits. "I think I had a better opportunity working for a nonaccounting firm," she says.  Now she is one of 13 former Ernst consultants at the center of a lawsuit that Ernst filed last month in a New York state court in Manhattan, accusing Alvarez & Marsal of raiding its tax and real-estate divisions' personnel, poaching its clients, interfering with its business and misappropriating confidential information.  Alvarez says it hasn't engaged in any improper conduct and argues that the suit is a sign of the accounting industry's struggle to adjust to the post-Enron Corp. world.
Jonathan Weil, "In Post-Enron World, Accounting Firms Fight Over the Pieces," The Wall Street Journal,  March 18, 2005,  Page C1 --- http://online.wsj.com/article/0,,SB111109239427082751,00.html?mod=todays_us_money_and_investing 
Bob Jensen's threads on auditor independence and professionalism are at http://www.trinity.edu/rjensen/fraud001.htm#Professionalism 

Three Cheers (make that 2.5 cheers) for Our Nation's Lawyers.
It took lawyers and litigation to start the civil rights, environmental protection, disability rights and anti-smoking movements. Legislators wouldn't act until the lawsuits caused change and produced publicity that led to laws and other reforms. For example, lawsuits aimed at smoking did what Congress refused to do: slashed smoking rates and returned hundreds of billions of dollars to taxpayers.  USA TODAY opposes the suits, arguing for public education and personal responsibility. But expensive taxpayer-funded government educational campaigns weren't very effective in reducing smoking, race discrimination, sexual harassment or other behaviors, while lawsuits were. Face it, personal responsibility by itself simply hasn't worked for obesity any better than it did for smoking and the others, and it isn't likely to.
John F. Banzhaf III, "Lawsuits can fight fat Legal action is more effective than public education programs," USA Today, January 31, 2005 --- http://www.usatoday.com/printedition/news/20050131/oppose31.art.htm 
Jensen's Paraphrasing of Portions of the Above Quotation:
For example, lawsuits aimed at preventing audit failures did what CPA firms internally refused to do: Make CPAs serious about incompetent auditing and unethical relationships with clients. Before the recent auditing scandals  (especially before Andersen's in-your-face lack of humility in the Waste Management scandal), Bob Jensen opposed lawsuits, arguing for auditor education and professional responsibility. But traditional college curricula and milk toast ethics policies weren't very effective in holding the line on auditor independence.  Face it, professional responsibility with caps on legal liability by itself simply won't work for auditors any better than it would for obesity, smoking and the others, and it isn't likely to.  Caps on liability make it profitable to be incompetent and, perhaps, even fraudulent.  The temptations for unrestrained sweet sugar, succulent fat, nicotine, and CPA client complicity and/or audit cost cutting are too irresistible.

Will it ever be possible to prevent Wall Street from becoming rotten to the core without freezing it?

This is a Very Depressing Commentary About Continued Rot

Investors appear to be losing the war with Wall Street
"The Street's Dark Side:  The markets can still be treacherous for investors," by Charles Gasparino, Newsweek Magazine, December 20, 2004 --- http://www.msnbc.msn.com/id/6700786/site/newsweek/ 

The hammer came down quickly on Wall Street after the stock-market bubble burst. Regulators and lawmakers, under pressure to avenge the losses of millions of average Americans duped by unscrupulous brokers and corporate book-cookers, imposed swift reforms. Eliot Spitzer, the crusading New York state attorney general, demanded big brokerage firms overhaul their fraudulent stock research (they had been hyping companies that paid them huge investment banking fees). Congress passed the Sarbanes-Oxley Act to tighten up accounting and other standards for corporate behavior. With the reforms in place, Wall Street was again "an environment where honest business and honest risk-taking will be encouraged and rewarded," William Donaldson, chairman of the Securities and Exchange Commission, declared in a speech last year.

Despite the changes, however, Wall Street remains a treacherous place for the small investor. The big financial firms are still rife with conflicts that put their own interests, and those of big banking clients, ahead of everyone else's. (Just last week, for example, Citigroup was fined $275,000 for steering customers to invest in certain Citigroup funds that were "unsuitable'' for them.) Also, watchdog agencies like the SEC, even with bulked-up resources, continue to be ill-equipped to root out corporate crime. And when investors think they've been cheated, the system for ruling on their complaints remains stacked against them. "There are all sorts of practices and conflicts of interest on Wall Street that still have to be addressed, " says John Coffee, a Columbia University law professor.

. . . 

Conflicts (Continued): During the 1990s, brokerage firms, regulators and lawmakers agreed to tear down the legal barriers that forced commercial bankers and investment bankers to operate independently. Wall Street quickly sought out merger partners, creating behemoths like Citigroup and JPMorgan Chase. They touted the convenience of one-stop shopping for consumers. But they also created incentives for staffers in different divisions to steer business to each other that would help the overall company. Spitzer's probe, for example, showed that many research analysts, supposedly peddling objective ratings, were working hand in glove with banking colleagues to win lucrative underwriting business from big corporate clients. The carrot for analysts: their compensation was tied in large part to the banking business they helped win. That's why analysts like Jack Grubman of Salomon Smith Barney told investors that he thought WorldCom was a "buy,'' even as it fell from more than $60 a share down to penny-stock territory.

Spitzer's settlement with Wall Street in 2002 was supposed to establish a higher wall separating banking and research; analysts could no longer work with bankers to pitch to corporate clients, and their pay had to be separated from such deals. But what's really changed? Analysts, under the guise of "due diligence,'' can still meet with executives around the time they're considering which investment bankers to hire. And many Wall Street firms acknowledge that investment-banking fees continue to flow into a pool of money used to pay analysts.

Are analysts' judgments more objective? Consider Google, which went public in August. Morgan Stanley's top Internet analyst, Mary Meeker, has been among Google's biggest boosters. Meeker was not supposed to play a direct role in helping Morgan land a slot to underwrite the IPO. But Morgan confirms that she did talk with Google founders Larry Page and Sergey Brin in meetings and lunches before the IPO. People familiar with the deal say those meetings helped play a big role in helping Morgan land the Google underwriting work. Meeker, along with the other four analysts whose firms underwrote the IPO, have been devoted cheerleaders of the stock, even as it has climbed from its $85 IPO price to above $171, a 101 percent increase in a matter of months. Clearly, it was a great call for those who bought at the outset. But many professional investors are now betting that at these levels, the stock is too pricey and due for a fall (recently the so-called short position on the stock jumped 34 percent in a month). Some Wall Street firms agree, particularly those who weren't part of the IPO underwriting. Morgan officials say that Meeker's call reflects her belief in the stock's potential.

Weak Watchdogs: If Wall Street firms could use a few more walls, the regulators charged with overseeing the firms could use fewer. The task of policing sprawling companies like Citigroup and JPMorgan Chase, which employ hundreds of thousands of people, is difficult enough. But the responsibilities for regulating them are also divided among different agencies—the Federal Reserve oversees banking, while the SEC regulates the securities side. NEWSWEEK has learned a nasty turf battle has erupted between the two agencies. The SEC wanted to examine possible leaks of confidential information from a firm's bank-debt departments to its trading desk. People at the SEC say it could open up a whole new area of insider-trading abuse. Counterparts at the Fed, however, "went nuts," according to a high-level SEC official, and tried to block the exam. SEC chairman William Donaldson conceded in a recent interview with NEWSWEEK that the Fed's mission has at times put it at odds with SEC. Neither agency would comment on the incident. "We're a cop,'' he said, noting that the Fed's main task is to protect the banking system. "We have two different roles," he added.

A more fundamental problem with much of Wall Street oversight is the notion of "self-regulation.'' Because of their limited resources, regulators ask Wall Street firms to police themselves in some areas. Their legal and "compliance" departments, for example, are supposed to provide "frontline'' regulation of their own brokerage departments. It doesn't always work out that way. Just ask Robert Pellegrini, who owns a winery on New York's Long Island. He says lax oversight allowed his financial adviser, Todd Eberhard, to steal about $1.2 million from his brokerage account. Eberhard later pleaded guilty to criminal securities fraud for making improper client trades, and he awaits sentencing that could land him in jail for 25 years. Pellegrini says in an arbitration claim that for several years, UBS PaineWebber processed Eberhard's illegal trades, despite numerous red flags. A simple background check by PaineWebber, his lawyer Jake Zamansky says, would have showed that three other firms refused to clear trades for Eberhard because of customer complaints. Eberhard Investment Advisors was not even registered with the NASD. A spokeswoman for PaineWebber said it "fully complied with its obligations as a clearing firm" and will "vigorously defend the allegations."

Justice Served? When customers like Pellegrini think they've been misled by a Wall Street broker, they have only one option for pressing their claim: to submit to arbitration. (Investors, when they sign up for a brokerage account, effectively sign away their right to use any system to settle a dispute.) But investors complain the deck is stacked against them, because the arbitrators are appointed by the industry, resulting in decisions that often favor the Wall Street firms. Investors won about half their cases last year, for example. Spitzer has said they should be winning more. Speaking before a private meeting of lawyers in Ft. Lauderdale, Fla., two weeks ago, Spitzer, according to a lawyer who was present, said he was frustrated that arbitration panels were blocking the use of evidence of conflicted research that he released as part of his investigation.

Investors appear to be losing the war with Wall Street in recovering money over conflicted research. Attorney Seth Lipner estimates that only 30 percent of all cases alleging that investors lost money because they relied on conflicted research has resulted in an award of money. Lipner blames the terms of the $1.4 billion settlement that Spitzer reached with Wall Street—the firms were allowed to pay the fine and agree to certain structural changes without having to admit guilt for misleading investors. "It has basically allowed arbitration panels to throw cases out," Lipner says. A spokesman for Spitzer says it's up to the courts to determine guilt, and that he simply laid out the evidence so investors could recoup their money. All of which proves that the best defense may be a twist on the old warning: caveat investor.

And to those who think SOX is a waste of time and money!
Note that Kodak's auditor is PwC!

From The Wall Street Journal Accounting Weekly Review on February 4, 2005

TITLE: Kodak to Get Auditors' Adverse View 
REPORTER: William M. Bulkeley and Robert Tomsho 
DATE: Jan 27, 2005 
PAGE: A3 
LINK: http://online.wsj.com/article/0,,SB110674149783836535,00.html  
TOPICS: Auditing Services, Internal Controls, Sarbanes-Oxley Act, Auditing

SUMMARY: "Kodak joins a growing list of corporations reporting [material internal control weaknesses] under new Sarbanes-Oxley rules that went into effect in November."

QUESTIONS: 
1.) What are the Sarbanes-Oxley requirements for auditors to provide reports on internal controls? How did that expand internal control work previously done for financial statement audits of publicly traded companies? (Hint: to answer questions 1 and 2, you may refer to on-line summaries of Sarbanes-Oxley requirements by the AICPA and the SEC at http://www.aicpa.org/info/sarbanes_oxley_summary.htm  and

http://www.sec.gov/news/press/2003-66.htm 

2.) Under Sarbanes-Oxley, who else besides auditors must report on publicly-traded companies' internal control systems?

3.) The author defines the term "material weakness in internal control" and then states that the disclosure of a material weakness isn't evidence that a misstatement in financial reporting actually has occurred. How can this be the case?

4.) Given that Kodak must have exhibited this internal control weakness in the past, what must have been the effect on audit procedures undertaken on the Kodak audit engagement?

5.) Compare and contrast the types of auditor's reports on internal control that are to be issued for Kodak and for SunTrut Banks, Inc. That is, based on the description in the article, how do you think these reports will differ?

Reviewed By: Judy Beckman, University of Rhode Island

"Kodak to Get Auditors' Adverse View," by William M. Bulkeley and Robert Tomsho, The Wall Street Journal, January 27, 2005, Page A# --- http://online.wsj.com/article/0,,SB110674149783836535,00.html 

Eastman Kodak Co. released preliminary fourth-quarter results in line with expectations, but said its auditors are expected to issue an "adverse opinion" citing "material weaknesses" in its internal financial controls for 2004.

Kodak joins a growing list of corporations reporting such problems under new Sarbanes-Oxley rules that went into effect in November. Earlier this month, SunTrust Banks Inc., Atlanta, said it will disclose a material weakness in its annual report. Last month Toys "R" Us Inc. disclosed that it was working to resolve unspecified internal-control issues.

so-called material weakness is a deficiency in record-keeping that is deemed likely to result in a misstatement of financial results. However, the disclosure of a material weakness isn't evidence that such a misstatement has actually occurred.

Kodak, of Rochester, N.Y., posted a preliminary fourth-quarter loss, reflecting restructuring costs and said revenue grew 3% as digital-product sales increasingly offset declines in film. Executives promised improved results this year.

In 4 p.m. New York Stock Exchange composite trading, Kodak stock was up 11 cents at $31.66 a share, as investors seem to be looking beyond the accounting issues because of emerging signs of the company's success in new imaging technology.

Kodak said that it is only able to report preliminary results because it discovered errors in its accounting of taxes for plant closings outside the U.S. It said it expects to report final results on schedule in its annual 10-K filing with the Securities and Exchange Commission in March, although it isn't clear whether any restatements of prior periods will be required.

Chief Financial Officer Robert Brust, meeting with investors in New York, said Kodak expects to strengthen financial controls by then, but said it expected the adverse PricewaterhouseCoopers opinion in any case. PricewaterhouseCoopers didn't return phone calls seeking comment on Kodak.

Amid more scrutiny of corporate bookkeeping, securities lawyers and accounting concerns expect the number of companies reporting such problems to grow. In an interview with Dow Jones Newswires from an economic forum in Switzerland yesterday, PricewaterhouseCoopers Chief Executive Samuel DiPiazza said he expected about 10% of U.S. companies to report that they either have material weaknesses or can't certify that their internal-control procedures are sound in time for their 2004 annual reports.

Such troubles are expected to be particularly widespread among smaller companies whose financial systems are newer and less refined. "The scuttlebutt in the Valley is that up to half of the companies could flunk," says Boris Feldman, a Palo Alto, Calif., securities lawyer whose firm represents a number of technology concerns in Silicon Valley.

For the quarter, Kodak reported a net loss of $12 million, or four cents a share, compared with net income of $19 million, or seven cents a share, in the year-earlier period. Revenue rose 3.2% to $3.77 billion from $3.65 billion.

Continued in the article

Some CPA Offices Can't Get Their SOX Up!

"Sorry, the Auditor Said, but We Want a Divorce," by Lynnley Browning, The New York Times, February 6, 2005 --- http://www.nytimes.com/2005/02/06/business/yourmoney/06audit.html 

Howard Root, chief executive of Vascular Solutions, got a jolt in September as he was preparing his company for a routine examination by Ernst & Young, the Big Four firm that had been its auditor since it was founded in 1997. Without warning, and less than three months before Vascular's annual report was due at the Securities and Exchange Commission, Ernst & Young quit.

But why? Mr. Root said that there were no financial improprieties or deteriorating prospects at Vascular Solutions, a medical devices maker based in Minneapolis. In fact, he said, the company had just reported record sales and shrinking losses. The company had no disagreements with Ernst & Young, he said.

Rather, Mr. Root said, Ernst & Young told him that it didn't have enough people to handle the mountain of extra work created by the Sarbanes-Oxley corporate watchdog act - especially for smaller clients like Vascular Solutions, which had net sales of around $20 million last year. The Sarbanes-Oxley law, passed in 2002, tightens accounting procedures and imposes new reporting rules on publicly traded companies and their outside auditors.

The timing of Ernst & Young's resignation was like "being served with divorce papers with no notice," Mr. Root said. "If you're going to get dropped," he added, "it's usually for the next year's work." A spokesman for Ernst & Young declined to comment.

. . .

The top auditing firms, collectively known as the Big Four, declined to say how much more the new law was costing their clients, though they all said it had sharply increased the amount of work they must do for clients, and the fees they charge. BDO Seidman, a so-called second-tier firm, says its fees have increased by 40 percent to 100 percent, if it agrees to retain the client at all.

John J. O'Connor, a vice chairman of PricewaterhouseCoopers, the nation's largest auditor based on revenue, said his firm had "raised the bar, made it a higher hurdle" in terms of how it decided to retain clients or take on new ones. Mr. O'Connor declined to say how many clients his firm dropped last year but said the reduction from July 2003 to June 2004 totaled 660,000 client hours, a single-digit percentage decrease.

James S. Turley, chairman and chief executive of Ernst & Young, testifying about Sarbanes-Oxley before a Senate committee last September, painted an image portraying some clients as ripe for divorce in the new risk-averse era.

"Our client acceptance and reacceptance processes," he said, according to a transcript, "have been re-engineered with an increased focus on determining which companies we really want as audit clients and culling out those that we do not believe have adapted to the new environment and demands on a public company." An Ernst & Young spokesman later said that the firm resigned from 88 clients last year, compared with 52 in 2003.

Only recently, the Big Four seemed willing to work with just about any corporate client - big or small, poky or fast-growing, publicly traded or private. But as more accounting scandals unfold, auditors are increasingly choosy about the companies they keep. No auditor wants to go the way of Arthur Andersen, which collapsed after it was convicted of obstruction of justice over its work for Enron. Arthur Andersen is appealing that verdict to the Supreme Court.

February 7, 2005 message from Taylor, Eileen [etaylor@COBA.USF.EDU]

Some companies are choosing to "go dark" or delist from the major stock exchanges because they can't afford to comply with Sarbanes-Oxley. Not exactly the result Congress was looking for... I imagine that even with good strong internal control, the documentation and compliance costs are just too high to justify remaining on the exchange.

Either way, the effect will be less transparency, rather than more. I also don't expect the stockholders to be overjoyed at voluntary delisting.

See article from the January 30, 2005 New York Times: Why Companies Delist... "...about 200 companies petitioned to delist their stocks in 2003, and he estimates that a similar number did so in 2004. In 2002, 67 companies went dark."

Looks like it would make an interesting study.

Eileen
University of South Florida
Eileen Taylor etaylor@coba.usf.edu

SOX Turned Inside Out

"Rein in the Public Company Accounting Oversight Board: Guest Article," by Peter J. Wallison, AccountingWeb, January 31, 2005 --- http://www.accountingweb.com/cgi-bin/item.cgi?id=100443 

By Peter J. Wallison, resident fellow at the American Enterprise Institute - The Public Company Accounting Oversight Board is a not-for-profit corporation established by the Sarbanes-Oxley Act to regulate the business of auditing public companies. Although industry self-regulatory organizations are not unusual, this one has the extraordinary power to tax all public companies to support its operations. Its freedom from the ordinary mechanisms of accountability for quasi-governmental functions is already having an effect, shown in its rapidly growing budget. But that is only one of the costs that this agency will impose on the economy. Before these costs get completely out of hand, Congress should intervene and bring it under control.

In all of the commentary about the Sarbanes-Oxley Act, not much attention has focused on the act's creation of the Public Company Accounting Oversight Board (PCAOB). This entity has some truly unique and troubling features. Although it was established by congressional legislation, it is a District of Columbia not-for-profit corporation, not a government agency. It is supposed to be a self-regulatory organization for the auditing activities of the accounting industry, but it is not supported by the industry it regulates; instead, it was authorized by Congress to fund itself by levying fees on all public companies--essentially a tax on the economy as a whole. Finally, although it is supposed to regulate the business of auditing public companies, no more than two of its five members--who must serve full-time--can have had backgrounds as accountants or auditors. This turns the whole concept of a self-regulatory body on its head. The original idea (of New Deal origin) was that industries could best regulate themselves because the regulators are experts in the way the industry functions; the PCAOB, however, was designed so as to prevent control by experts in accounting or auditing. This apparent bias against the accounting profession--so that accountants were not even permitted to control their own so-called self-regulatory organization--is a direct result of the overheated atmosphere in which the Sarbanes-Oxley Act was legislated. Passed in the wake of the Enron and WorldCom scandals, the act reflected hostility and distrust of corporate managements and the accounting profession, and out of this grew the regulations of Nasdaq and the NYSE that required public companies to be governed by boards with majorities of "independent" directors. In boardrooms, the act has impaired the collegiality that once prevailed between directors and management, and may be impairing the management risk-taking that is an essential element of economic growth. But for the accounting profession, it has created a sense of adversity between accountants and their regulator. Important rules and standards, which will profoundly affect the cost of audits and how auditors deal with their clients, are being developed by an inexperienced board staff that, from all reports, is keeping practicing accountants and auditors--those who understand the costs and issues involved--at arm's length. This is a prescription for trouble that the business community will ignore to its regret.

Although Congress has in the past authorized the creation of nongovernmental organizations, such as the Municipal Securities Rulemaking Board (MSRB), to regulate particular sectors of the economy, these self-regulatory organizations (known as SROs) have always been selected from and financially supported by the industry they regulate. The PCAOB, however, is not funded by the accounting profession but by fees levied on over 8,400 public companies. This is a significant difference, which raises questions about both the constitutionality of this organization and the degree to which its power and reach can be controlled.

It is difficult to imagine, for example, that Congress could constitutionally delegate to a private company what is essentially the power to tax the entire economy in support of its regulatory activities. There may be room in constitutional theory for SROs--regulatory bodies composed of industry members and supported by an industry--but under what principle can Congress authorize private companies to exercise what seem to be governmental regulatory powers and to support themselves through a delegated power to tax? On a more technical level, the Securities and Exchange Commission (SEC) appoints the members of the PCAOB, and constitutional scholars may wonder how this could have complied with the appointments clause of the Constitution, which clearly vests "in the President alone" appointments of officers of the United States. To be sure, the Sarbanes-Oxley Act declares that the members of the board and their staff are not "officers of the United States," but it seems highly unlikely that Congress can avoid the appointments clause simply with a form of words, or by authorizing a private corporation to do what the government itself would otherwise do.

The constitutionality of the PCAOB is an important issue that is likely to reach the courts in conjunction with its first major enforcement action, but this issue of the Financial Services Outlook will primarily consider a narrower question--whether there are any effective checks on the growth of the PCAOB and the costs it will continue to impose on the economy. As outlined below, by permitting the PCAOB to fund itself by taxing all public companies, Congress has freed the organization from all controls that normally place necessary and practical limits on the activities of both explicit government agencies and SROs.

Unchecked Authority

It is an axiom of American government that the exercise of all governmental power is subject to control. At the highest level, of course, the executive, legislative, and judicial branches of the government are all bound in a constitutional web of checks and balances. In this structure, Congress controls the other branches through its power to appropriate funds for their operations. Because the PCAOB has the power to make and enforce its own regulations, to hold disciplinary proceedings, and to impose penalties, there is little doubt that it has the normal attributes of a government agency. Yet, because it is authorized to tax all public companies in order to support its operations, it is able to operate free of the normal constraints on government agencies.

To be sure, the Sarbanes-Oxley Act placed the PCAOB under the general oversight and control of the SEC, which has the authority to appoint the members of the board, to remove them "for cause," to approve the board's regulations and annual budget, and--significantly--to assign other responsibilities to the board. While on its face this degree of authority would appear significant, a fuller consideration of the sources of the board's independence and the SEC's institutional interests suggests that under the current arrangement real and sustained control is likely to be illusory.

Through the annual appropriations process, Congress balances agency requests for funds against other priorities, and thus exercises practical control over the scope of agency activities by limiting agency resources. In addition, congressional committees with jurisdiction over particular areas of government activity conduct annual reviews of agency operations and effectiveness, and these oversight functions also place practical limits on the scope of agency activities. No similar structures exist for the PCAOB. Since it does not rely on congressional appropriations for its funding, there is little regular oversight of the board through the appropriations process, and as a private company that operates as a kind of subsidiary of the SEC there is no occasion for Congress to review the board's activities through regular oversight hearings. In its two years of operations, the board seems to have had only one oversight hearing--in a House subcommittee in June 2004.

Moreover, unlike other SROs, the PCAOB is not subject to any control by the industry it regulates. Indeed, as noted above, Congress designed the PCAOB so that it would be insulated from influence by the accounting profession. When an industry SRO is composed of and funded by members of the industry, there is an informal mechanism of control: the regulated industry, with an interest in reducing unnecessary expenditures, keeps a close watch on how much its SRO spends, and this in turn places an informal restriction on the regulatory reach of the agency. The members of the industry who serve on the governing board of the SRO--generally in part-time roles--are constantly in touch with others in the industry and receive critical commentary and feedback about the quality of the SRO's work. These informal elements of control over an SRO are missing in the case of the PCAOB. A majority of its board may not by law be members of the accounting profession, and since the board serves full-time, its members are isolated from day-to-day contact with accountants and auditors. Finally, and perhaps most important, the PCAOB is not funded by the industry it regulates, so the accounting profession has no financial incentive to pay attention to the organization's spending.

Continued in the article

"SEC Steps Up Effort to Fight Stock Fraud," by Deborah Solomon, The Wall Street Journal, February 2, 2005, Page D1 --- http://online.wsj.com/article/0,,SB110729717180142868,00.html?mod=todays_us_personal_journal

The Securities and Exchange Commission, trying to head off potential stock-fraud schemes before investors get hurt, has started to halt trading in companies whenever illicit stock touting is suspected.

The move is part of the agency's broader attempt to get ahead of possible fraud before it becomes widespread. Over the past week, the SEC temporarily suspended trading in two companies when regulators believed a campaign to artificially inflate the price of shares was under way. The agency is expected to suspend trading in several other companies within the coming weeks and months, according to people familiar with the matter.

On Monday, the SEC halted trading in Commanche Properties Inc., a Tucson, Ariz.-based motion-picture company, and last week halted trading in Courtside Products Inc., a family-run business in Spokane, Wash., that sells sporting-equipment bags. In both cases the companies were listed on the pink sheets -- where small stocks are traded over the counter -- but hadn't registered as public companies. The trading suspensions last for 10 days. A phone call to Commanche wasn't returned.

At issue is the potential for so-called pump-and-dump schemes, whereby speculative investors, company insiders or others try to inflate demand for a stock by trumpeting positive-sounding information about a company -- typically via e-mail -- and then cash in their shares at the higher price. Often the information is false and the stock quickly declines again.

Continued in the article

"Coziness comes back to bite auditing firms," by Andrew Leckey, Chicago Tribune, January 2, 2005 --- http://www.chicagotribune.com/business/investing/personalfinance/chi-0501020216jan02,1,5957974.story?coll=chi-businessyourmoney-hed

No matter how elite, historic or long an auditing firm's name may be, it gets the boot when a corporation's numbers don't add up.

This fall from grace of the accounting superpowers actually began in the mid-1980s.

Known as the Big Eight, the premier firms consisted of Arthur Andersen, Coopers & Lybrand, Deloitte Haskins & Sells, Ernst & Whinney, Peat Marwick Mitchell, Price Waterhouse, Touche Ross and Arthur Young.

Every accounting major and aspiring CPA could recite those names. Accounting and management consulting were professions of high pay and prestige, especially for those on track to become partners.

But the giant numbers-crunching firms had already reached their pinnacle. They began merging, just as the many corporations they audited were doing. In 2002, only Andersen, Ernst & Young, Deloitte & Touche, KPMG and PriceWaterhouseCoopers remained of the original group.

That's the year Andersen imploded along with its failed audit client Enron. A felony conviction for obstructing justice led to the dissolving of its accounting practice. Andersen was no more.

We now enter 2005 with a Big Four that has much less independence. They are answerable to a Public Company Accounting Oversight Board named by the Securities and Exchange Commission and must follow guidelines of the Sarbanes-Oxley Act.

Each accounting giant also faces huge lawsuits that seek to tag it with responsibility for permitting corporate financial deception. If several major judgments were to come down against any one firm at once, it might signal its demise.

Meanwhile, client companies are dumping the Big Four as auditors to cut costs and gain a closer relationship with a smaller auditor. In addition, most of the Big Four have sold off or laid off their lucrative management consulting operations.

For large corporate clients, the finite number of huge accounting firms with the capacity to handle their business makes it difficult to replace auditors. They also can't audit firms that already provide them with non-audit services.

Corporations and their auditors are in a fix, but a fix of their own making. The cozy relationship that benefited both parties over decades set the table for financial disasters that penalized shareholders and employees.

The fall from grace of the elite accounting firms was in some ways justified. Now the entire accounting profession must unite to prove that accurate reporting is a higher priority for them than privilege or fat billings.

Bob Jensen's threads on auditor independence are at http://www.trinity.edu/rjensen/fraud001.htm#Professionalism 

The rules that the statute imposes for selection of the members of the committee give no guarantee that the right people will be found to serve onit. Indeed, many eminent professors of accounting cannot serve on audit committees because they do not have the requisite level of practical experience.
Richard Epstein, "In Defence of theCorporation," December 2004 ---  http://www.nzbr.org.nz/documents/publications/publications-2004/in_defence.pdf 

"S.E.C. Gives Foreign Firms Some Hope on New Rules," by Heather Timmons, The New York Times, January 26, 2005 --- http://www.nytimes.com/2005/01/26/business/worldbusiness/26donaldson.html?oref=login 

William H. Donaldson, chairman of the Securities and Exchange Commission, said here Tuesday that the commission was considering tweaking some rules for overseas companies listed in the United States, after an outpouring of foreign criticism of the Sarbanes-Oxley Act.

Mr. Donaldson said that the S.E.C. was also considering making it easier for foreign companies to delist from exchanges in the United States, and that it planned to consider requiring fewer years of past financial statements that comply with United States accounting principles.

The agency would also consider pushing back the deadline for foreign companies to comply with the Sarbanes-Oxley rules on internal controls, Mr. Donaldson said. At present, that deadline is the next annual report that comes after April 15 of this year.

The S.E.C. "remains committed to a level playing field for all its issuers, foreign and domestic alike," Mr. Donaldson said in a speech before several hundred business executives and students at the London School of Economics. "But we recognize that cross-border listings frequently entail issuers having to navigate duplicative or even contradictory regulations."

The S.E.C.'s willingness to consider changes is the first sign that some concessions might be made for foreign companies whose shares are listed in the United States. Since the Sarbanes-Oxley Act was passed in 2002, some overseas companies have been trying to delist from American stock markets and others have opted to list elsewhere because they say the expense of complying with the rules outweighs the benefits.

As a consequence, United States delisting rules have come under fire. According to a rule that dates back decades, companies with 300 or more shareholders in the United States cannot delist their shares from the exchange where they trade. Consequently, they need to comply with Sarbanes-Oxley.

"U.S. federal securities laws and regulations on this issue were designed many years ago," Mr. Donaldson noted, and should be revised to "preserve investor protection without inappropriately designing the U.S. capital market as one with no exit." The S.E.C. is weighing whether there should be a "new approach" for foreign issuers that want to delist, he said.

In addition, the S.E.C. is rethinking how it treats companies listed in Europe that must convert to the European Union's new international foreign reporting standards. In coming months, Mr. Donaldson said he expected the S.E.C. to look at a proposal to allow those using the new European standards to reconcile two years of financial statements to United States accounting principles, instead of three.

"'Fair Disclosure' Inhibits Speech, U.S. Chamber of Commerce Says," by Phyllis Plitch, The Wall Street Journal, January 20, 2005, Page C3 --- http://online.wsj.com/article/0,,SB110617311498830579,00.html?mod=todays_us_money_and_investing 

In its latest effort to limit the Securities and Exchange Commission's power, one of the nation's top business groups has slammed the agency's so-called fair-disclosure rule as a constitutionally suspect, congressionally unsanctioned intrusion into corporate affairs.

Diving into the first challenge of the SEC's four-year-old Regulation FD, the U.S. Chamber of Commerce has filed court papers in support of Siebel Systems Inc.'s attempt to dismiss an SEC action against the company.

"In punishing companies for selectively disclosing 'material and nonpublic' information, Regulation FD impairs fundamental First Amendment values," the chamber wrote in its friend-of-the-court brief. "It either compels corporate executives to engage in unwanted discourse with the public at large, thereby inhibiting their right to freedom of speech and association, or causes them to restrict their speech altogether to avoid violation of the regulation."

In seeking to weigh in on the Siebel case, the chamber is once again showing its willingness to come between the nation's top securities regulator and the U.S. companies and investment firms under its watch. The organization is also challenging the SEC's authority to pass new standards forcing 75% of mutual-fund directors to be independent.

In many respects, the chamber's arguments parallel those made by Siebel in its own court papers. In its motion to dismiss the SEC's complaint, the San Mateo, Calif., business-software company also argued that the agency lacked statutory authority to pass the regulation and that the regulation violates the First Amendment.

Continued in the article

Now firms must simultaneously hire three or four of the Big Four:  Is this shadows and mirrors?

"Auditors: The Leash Gets Shorter:   Providing tax services to audit clients will no longer be allowed," Business Week, December 27, 2004, Page 52 --- http://www.businessweek.com/@@5NnjCIcQuePg7RMA/magazine/content/04_52/b3914040_mz011.htm 

For years, Sun Microsystems Inc. (SUNW ) looked to its auditor, Ernst & Young International, to provide all manner of advice on other financial matters. But recently the Santa Clara (Calif.) high-tech company has started to shop elsewhere. PricewaterhouseCoopers now handles Sun's internal audit, KPMG International helps test financial controls, and Deloitte Touche Tohmatsu prepares tax returns for Sun's expatriate employees. With new federal rules beefing up the audit process, "it's our firm belief that [Ernst & Young] should focus specifically on the audit," says Stephen T. McGowan, Sun's chief financial officer.

Sun is not alone. After auditors failed to catch financial fraud at Enron and WorldCom (now MCI), Congress ordered companies to quit hiring their auditors for a slew of services, from bookkeeping to computer-systems design. The 2002 Sarbanes-Oxley corporate-reform act left it up to boards' audit committees to decide whether the same accounting firm could provide other services -- including tax advice. But with audit committees eager to avoid any chance for conflicts, more companies, from General Electric to Home Depot to American Express, are switching their tax work, too.

Now they have another reason to play it safe. On Dec. 14, the Public Company Accounting Oversight Board proposed stricter curbs on audit firms selling tax services to their clients. The board, created by Sarbanes-Oxley, says it wants to ban auditors from promoting aggressive tax shelters to client companies and their top execs. It also wants to keep them from accepting contingent fees, payments based on a percentage of their clients' tax savings. Also off limits: offering tax services to top company officers. The rules, which must be approved by the Securities & Exchange Commission, "draw clear lines to distinguish inappropriate services that impair auditor independence from permissible services that are not detrimental," says PCAOB Chairman William J. McDonough.

Investors are ahead of regulators. For the past two years, Institutional Shareholder Services, a proxy-advice service, has urged the investors it advises to vote against rehiring auditors who collect more in consulting fees than they do from the audit and audit-related work. The share of Standard & Poor's 500-stock index companies failing that test fell from 60% in 2002 to just 2% this year.

INCREASED COMPETITION The Sarbanes-Oxley restrictions, along with better disclosure, drove much of that improvement, but boards are going beyond the law's strictures. "When in doubt, I want to turn away from the audit firm for anything except auditing," says professor Paul R. Brown of the Stern School of Business at New York University, who also sits on the audit committee of French aerospace company Dassault Systèmes.

The upshot: The average amount a large U.S. company paid its auditor for tax services fell 14%, to $1.9 million, in 2003, according to a study by Glass, Lewis & Co., a proxy-research firm. Jonathan Hamilton, editor of Public Accounting Report, figures tax fees could fall 5% to 10% in 2005 if the SEC blesses the new rules.

Critics have long accused the Big Four firms of underpricing their audits so they can charge hefty fees for consulting. But as businesses pull back tax work and offer it to the competition, rates are falling. Sun, which was paying Ernst & Young $3.5 million a year for expatriate tax services, found Deloitte was willing to do the work for just under $3 million.

The Big Four aren't necessarily losing out. Audit fees are rising as accountants scrutinize financial statements more extensively, and consulting work taken from the auditor usually ends up at another Big Four firm. Still, second-tier accounting firms and lawyers are gaining. Grant Thornton International, for example, recently took on state and local tax assignments from R.R. Donnelley & Sons Co. and Marriott International Inc.

The downside to spreading the consulting work: With only four international firms to choose from, a multinational can't switch auditors without having to reshuffle consultants for its tax, info-tech, and human-resources departments. Still, investors will be better off if auditors' independence isn't compromised by fat fees for other services.

December 20, 2004 reply from Robert B Walker [walkerrb@ACTRIX.CO.NZ]

An interesting story, but surely it contains a non-sequitur. In the seventh paragraph the story suggests that critics of cross-selling were wrong in claiming that there was a relationship between audit lowballing and consulting fees, citing the example of EY and Deloitte at Sun. I would have drawn the opposite conclusion - that is, the fact that the auditors no longer had privileged access for the purpose of pecuniary gain, the price fell.

As a failed auditor, having been driven from the field by predatory pricing, I now watch with some irritation the way in which the remaining mega-firms are now holding the world to ransom. Given that it is practically impossible for other accounting firms to re-enter the field, the only solution is to open the field again by allowing in other, well capitalised firms such as banks, insurers etc. I, for one, would be happy to see an audit opinion by AIG or Citibank. Frankly, whilst Mr Spitzer may have demonstrated organisations such as these lack a sense of virtue, they are relative paragons by comparison.

The law creates an insurmountable legal barrier to entry. This barrier promotes the existence of what has become an effective cartel. This would be a difficult barrier to break down as it would require the concerted efforts of a variety of national jurisdictions. However, I am sure the SEC has enough clout to make the change happen

Bob Jensen's threads on auditor independence are at http://www.trinity.edu/rjensen/fraud001.htm#Professionalism 

Question
What are hedge funds and why are they so controversial?

Answers

Definition from VAN --- http://www.hedgefund.com/abouthfs/what/what.htm 

A hedge fund can be classified as an alternative investment. Alternative investments are investments other than stocks and bonds. A U.S. "hedge fund" usually is a U.S. private investment partnership invested primarily in publicly traded securities or financial  derivatives. Because they are private investment partnerships, the SEC  limits U.S. hedge funds to 99 investors, at least 65 of whom must be "accredited." ("Accredited" investors often are defined as investors having a net worth of at least $1 million.) A relatively recent change in the law (section 3(c)7) allows certain funds to accept up to 500 "qualified purchasers." In order to be able to invest in such a fund, the investor must be an individual with at least $5 million in investments or an entity with at least $25 million in investments. The General Partner of the fund usually receives 20% of the profits, in addition to a fixed management fee, usually 1% of the assets under management. The majority of hedge funds employ some form of hedging -- whether shorting stocks, utilizing "puts," or other devices. 

Offshore hedge funds usually are mutual fund companies that are domiciled in tax havens, such as Bermuda, and that can utilize hedging techniques to reduce risk. They have no legal limits on numbers  of non-U.S. investors. Many accept U.S. investors, although usually only tax-exempt U.S. investors. For the  purposes of U.S. investors, these funds are subject to the same legal guidelines as U.S.-based investment partnerships; i.e., 99 U.S. investors, etc. 

Hedge funds are as varied as the animals in the African jungle. Over the years, many investors have assumed that hedge funds were all like the famous Soros or Robertson funds - with high returns, but also  with a lot of volatility. In fact, only a small percentage of all hedge funds are "macro" funds of that type. Among the others, there are many that strive for very steady, better-than-market returns. VAN tracks 14 different styles of hedge funds, in addition to a number of sub-styles.

The Loophole:  Locked-up funds don't require oversight.  That means more risk for investors.
"Hedge Funds Find an Escape Hatch," Business Week, December 27, 2004, Page 51 --- 

Securities & Exchange Commission Chairman William H. Donaldson recently accomplished a major feat when he got the agency to pass a controversial rule forcing hedge fund advisers to register by 2006. Unfortunately, just weeks after the SEC announced the new rule on Dec. 2, many hedge fund managers have already figured out a simple way to bypass it.

The easy out is right on page 23 of the new SEC rule: Any fund that requires investors to commit their money for more than two years does not have to register with the SEC. The SEC created that escape hatch to benefit private-equity firms and venture capitalists, which typically make long-term investments and have been involved in few SEC enforcement actions. By contrast, hedge funds, some of which have recently been charged with defrauding investors, typically have allowed investors to remove their money at the end of every quarter. Now many are considering taking advantage of the loophole by locking up customers' money for years.

TROUBLING QUESTIONS 
Securities lawyers say phones are ringing off the hook with questions from hedge funds considering circumventing registration. Some firms have already held small seminars packed with hedge fund managers discussing the potential cost and hassle of registering. Analysts estimate there are over 7,000 hedge funds, with roughly $1 trillion in assets; many may be looking for an out. Lindi L. Beaudreault, an attorney at Washington-based law firm LeClair Ryan estimates that "one third of unregistered hedge fund advisers are seriously considering locking up their investors' money for two years" to avoid registering.

Hedge funds seeking to skirt SEC registration raises troubling questions given their recent track record. In the last five years, the SEC has authorized or brought 51 cases against hedge fund advisers for allegedly defrauding investors of over $1 billion. And some SEC officials are already conceding that the exemption could be problematic. "If we see a significant invasion of the rule, we'll have to rethink," says Paul F. Roye, director of the division of investment management at the SEC.

The SEC did anticipate that some hedge funds would try to take advantage of the loophole. It concluded that investors would have the smarts to steer clear of any fund trying to evade the rule. But it may be tough for investors to distinguish between funds that are lengthening their so-called lockup periods simply to avoid registering, versus those with legitimate reasons for a longer investment horizon, such as a strategy based on turning around troubled companies. Already, investors in 5% of hedge funds with more than $1 billion in assets, many of which had voluntarily registered before the rule was introduced, have agreed to funds' demands that they hand over their money for two years or more, according to Chicago-based researcher Hedge Fund Research Inc. Still, if hedge fund exceptions become the rule, Donaldson's coup might turn out to be a Pyrrhic victory.

Bob Jensen's threads on "Rotten to the Core" are at http://www.trinity.edu/rjensen/fraudRotten.htm 

Regulators are concerned about Wall Street firms tipping off selected investors to information about securities offerings.
"Securities Cops Probe Tipoffs Of Placements," by Ann Davis, The Wall Street Journal, December 16, 2004; Page C1 --- http://online.wsj.com/article/0,,SB110315579554001426,00.html?mod=home_whats_news_us 

Regulators are examining whether insiders at Wall Street firms that oversee big securities offerings for corporate clients have tipped off selected investors with valuable information about deals that can cause stock prices to fall.

Two recent cases demonstrate the regulators' concern: Federal prosecutors this week charged a former SG Cowen trader with trading on confidential knowledge that the firm's corporate clients were about to issue millions of dollars of new stock. Last month, the Ontario Securities Commission in Canada accused the Canadian brokerage house Pollitt & Co. and its president in a civil action of tipping off some clients to a pending deal involving bonds that could later be converted to stock. The Ontario authorities also accused one client of acting on the tip.

Regulators also are concerned about inadvertent tip-offs. The Securities and Exchange Commission, the New York Stock Exchange and other regulators are especially worried about information related to corporate stock and bond deals that are executed quickly, sometimes overnight. Such deals require brokerage houses to contact potential buyers to see if they are interested in buying the newly available securities, thereby giving them insider information that could be misused. (See a related article.)

Continued in article

Bob Jensen's "Rotten to the Core" threads are at http://www.trinity.edu/rjensen/fraudRotten.htm 

Bob Jensen's fraud conclusions are at http://www.trinity.edu/rjensen/FraudConclusion.htm 

"The Mutual Fund Trading Scandals," by Brian Carroll, Journal of Accountancy,  pp. 32-37 --- http://www.aicpa.org/pubs/jofa/dec2004/carroll.htm 

EXECUTIVE SUMMARY SINCE THE FIRST MAJOR MARKET-TIMING and late-trading scandal broke, a barrage of federal and state enforcement actions against funds has followed. LATE-TRADING IS ILLEGAL UNDER FEDERAL securities laws and some state statutes. It occurs when a mutual fund or intermediary permits an investor to purchase fund shares after the day’s net asset value is calculated, as though the purchase order were placed earlier in the day. THE SEC HAS ADOPTED A NEW RULE requiring a fund to disclose in its prospectus and statement of additional information its market-timing risks; policies and procedures adopted, if any, by the board of directors, aimed at deterring market-timing; and any arrangement that permits it. THE SEC HAS PROPOSED A NEW RULE that generally would require all mutual fund trades to be placed by a “hard 4 p.m.” Eastern time deadline.  IN CONTRAST TO LATE-TRADING, MARKET-TIMING is not illegal per se. Problems arise, however, when the timing of trades violates the disclosures in the prospectus. This can cause so many buys and sells that the costs escalate and the fund is disrupted, to the detriment of its long-term shareholders. Brian Carroll, CPA, is special counsel with the U.S. Securities and Exchange Commission in Philadelphia. He also is an adjunct professor at Rutgers University School of Law in Camden, New Jersey. The U.S. Securities and Exchange Commission disclaims responsibility for any private publication or statement of any commission employee or commissioner. This article expresses the author’s views and does not necessarily reflect those of the commission, the commissioners or other members of the staff.

Bob Jensen's threads on the mutual fund scandals are at http://www.trinity.edu/rjensen/fraudRotten.htm#MutualFunds 

It's a change in philosophy for an agency that has spent the last couple of years chasing after wrongdoing uncovered by New York Attorney General Eliot Spitzer. Throughout the spate of corporate scandals, the SEC has been conducting investigations after the fact, levying fines on companies long after the abuse has occurred, and failing to spot questionable practices, such as mutual fund trading abuses.   Donaldson (SEC Chairman) wants to change that by taking a cue from Spitzer. Spitzer's strategy was to narrow his focus and concentrate on areas where small investors were being harmed. The SEC will do the same through a newly formed office of Risk Assessment, the Washington Post reported.
"SEC Chairman: Find Solutions Before Problems Explode," AccountingWeb, September 30, 2004 --- http://www.accountingweb.com/cgi-bin/item.cgi?id=99840 

According to a joint survey by PricewaterhouseCoopers and the Economist Intelligence Unit, financial institutions have equated good corporate governance with meeting the demands of regulators rather than improving the quality of management. PwC suggests how to comply and improve in order to reap the potential strategic advantages of improved governance.
SmartPros, April 7, 2004 --- http://www.smartpros.com/x43179.xml 

AICPA Launches Web Site to Promote Audit Quality --- http://cpcaf.aicpa.org/ 

In a landscape that has changed dramatically over the past few years by corporate finance scandals, stricter government oversight and regulation, the Center for Public Company Audit Firms provides you the timely, comprehensive technical and educational information you need to conduct high quality audits of SEC issuers.

 

Learn more about the Center and its mission.

 

For valuable resources and tools on subjects such as the SEC, PCAOB, and Sarbanes-Oxley, click on the Resources tab.

 

The saga of auditor professionalism and independence --- http://www.trinity.edu/rjensen/fraud001.htm#Professionalism 

SOX Internal Control Investor Resource Guides

Forwarded by Dennis Beresford on 

• Internal Control Over Financial Reporting: An Investor Resource
  

Designed as a broad overview of Section 404 of the Act, this brochure explains the background and rationale for the new reports, provides a brief description of what the new reports will include, and explains the meaning of control deficiencies, management’s report and the independent auditor’s opinion.

• Perspectives on Internal Control Reporting: A Resource for Market Participants
  

More detailed and in depth, this publication, in question and answer format, is designed for investors and other market intermediaries including brokers, analysts and rating agencies interested in additional information on specific topics related to internal control reporting, material weaknesses, and the potential marketplace implications of the new reporting.

A majority of financial executives (57 percent) say Sarbanes-Oxley (SOX) compliance was a good investment for stockholders, according to a report released this month by Oversight Systems, the 2004 Oversight Systems Financial Executive Report On Sarbanes-Oxley Compliance, a nationwide survey of 222 financial executives.
"Financial Execs Call SOX 'Good Investment'," SmartPros, December 22, 2004 --- http://www.smartpros.com/x46291.xml 

Ernst & Young's Chairman and CEO Jim Turley notes in a Wall Street Journal article that Section 404 of the US Sarbanes Oxley Act is a critical step in enhancing investor confidence. He adds that the law entails a major risk in its first year "that the opinions on internal controls provided by management and independent auditors may be misinterpreted by the market." But the bottom line is, "investors will derive significant benefits from the implementation of Section 404. And the markets, in turn, will benefit from the enhanced investor confidence."
E&Y Faculty Connection --- http://www.ey.com/global/content.nsf/International/Home 
Bob Jensen's threads on proposed reforms are at http://www.trinity.edu/rjensen/FraudProposedReforms.htm 

Sarbanes-Oxley Reference Articles --- http://www.fmsinc.org/cms/?pid=3253

Sarbanes-Oxley and Investor Resource Guides

• Internal Control Over Financial Reporting: An Investor Resource - Designed as a broad overview of Section 404 of the Sarbanes-Oxley Act, this brochure explains the background and rationale for the new reports, provides a brief description of what the reports will include and explains the meaning of control deficiencies, management’s report and the independent auditor’s opinion.

   

• Perspectives on Internal Control Reporting: A Resource for Market Participants - More detailed and in depth, this publication, in question and answer format, is designed for investors and other market intermediaries including brokers, analysts and rating agencies interested in additional information on specific topics related to internal control reporting, material weaknesses, and the potential marketplace implications of the new reporting.

These guides were jointly developed by Deloitte & Touche LLP, Ernst & Young LLP, KPMG LLP and PricewaterhouseCoopers LLP around a shared commitment to investor education.

 

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

Reining in the CPA Hucksters

All the Big Four and other CPA firms were huckstering abusive tax shelters, with KPMG being the worst of the lot --- http://www.trinity.edu/rjensen/fraud001.htm#KPMG 

"Auditing-Rule Maker Seeks New Limits On Tax Services," by Jonathan Weil, The Wall Street Journal, December 15, 2004, Page C3 --- http://online.wsj.com/article/0,,SB110306143764900061,00.html?mod=home%5Fwhats%5Fnews%5Fus 

The auditing profession's chief regulator unveiled a broad proposal aimed at preventing accounting firms from auditing the books of public companies to which they have sold tax shelters that the Internal Revenue Service deems abusive tax-avoidance schemes.

The proposal by the two-year-old Public Company Accounting Oversight Board also would prohibit accounting firms from selling any tax services at all to senior officers of publicly held audit clients. Until recently, regulators had seen little need to pass significant restrictions on firms' ability to sell tax services to audit clients, believing they created few conflicts of interest. In the past two years, however, several highly publicized controversies have called that premise into question.

Last year, Sprint Corp.'s board forced the resignations of the long-distance company's top two executives after learning that the IRS was challenging tax shelters they had purchased from the company's independent auditor at the time, Ernst & Young LLP. And Senate hearings last year into KPMG LLP's tax-shelter practices revealed numerous examples in which the firm had mass-marketed allegedly abusive strategies to audit clients.

The tax proposal comes on top of Securities and Exchange Commission restrictions, passed in 2000 and 2003, limiting consulting and other nonaudit services by auditors. "This is a time when the most important task of the profession is to restore the investing public's confidence in the quality, integrity and worth of its work on the public's behalf," said William J. McDonough, chairman of the accounting board, which voted 5-0 to submit the proposal for public comment. "The appearance that some in the profession assist corporate and other privileged clients to evade the rules, whether they are tax rules or accounting rules, threatens the restoration of public confidence."

Some auditors began signaling displeasure with the board's auditor-independence initiative on tax services months ago. In a Sept. 22 letter to Rep. Richard Baker, chairman of the House subcommittee that oversees the accounting board, Deloitte & Touche LLP Chief Executive Officer James Quigley said his firm believes the issue should be "addressed by tax regulation, legislation and the courts, rather than through independence regulation with a sole focus on auditors."

Deloitte, Ernst and PricewaterhouseCoopers LLP officials declined to comment on the proposal's specifics yesterday. In a statement, KPMG said that "the proposed rules appear to be balanced and provide a level of clarity concerning what is or is not a permissible tax service."

After a 60-day comment period, the accounting board's proposal is set to take effect in October 2005. Here's a look at the highlights:

Corporate tax shelters: In the future, an accounting firm would be disqualified as a company's independent auditor if it sells the company a tax shelter already included on the IRS's published list of abusive tax-avoidance strategies -- or a shelter substantially similar to an IRS-listed strategy. Generally speaking, the rules wouldn't disqualify auditors in connection with tax services completed before Oct. 20, 2005.

The auditor also would be disqualified if it requires the client to sign a confidentiality agreement barring disclosure of the strategy. Additionally, firms selling tax strategies to audit clients would be disqualified if later found to have lacked a reasonable basis for believing that a given strategy "more likely than not" would pass muster with tax authorities.

Accounting firms also might be disqualified, depending on the circumstances, in other situations where they would be in the position of having to audit their own tax-shelter work. Such situations can arise when a firm sells an audit client a tax strategy that the IRS later adds to its list of abusive transactions and where the strategy's accounting effects have a material impact on the client's financial statements. The accounting board said it would seek further public comments on this point before deciding how to proceed.

Tax services for executives: Yesterday's proposal would impose an outright ban on selling tax services to an audit client's senior officers. Some big accounting firms, including Ernst, have said their clients' audit committees already have cut back substantially on letting them perform such work, in the wake of the Sprint episode.

Firms still would be allowed to sell tax services to an audit client's corporate directors -- even the audit-committee members to whom they report, a point likely to draw criticism from some investors. Additionally, the board decided not to propose a ban on preparing tax returns for audit-client employees working in foreign countries.

Contingent fees: Despite an existing SEC ban on such fee arrangements with audit clients, they remained standard practice until recently at some accounting firms. These firms based their tax-shelter fees on a percentage cut of clients' tax savings. Now, the accounting board says it wants to formally include the contingent-fee ban in its own auditing standards.

Bob Jensen's "Saga of Auditor Professionalism and Independence" is at http://www.trinity.edu/rjensen/fraud001.htm#Professionalism 

Part of a December 13, 2004 message from Ethical Performance [list_admin@ethicalperformance.com] 

One of the world's largest consumer products groups has begun posting online details of its policies on key aspects of corporate social responsibility.

Procter & Gamble is featuring the information on its website, at http://pgperspectives.com in response to requests from its stakeholders for more transparency on product safety, the environment and sustainability.

The company, which has five billion consumers, has arranged the material in a way that enables visitors to find information on a specific topic without having to wade through endless links.

Procter & Gamble directs visitors to information provided not only by itself, but also by third parties, including research commissioned by pressure groups that are perhaps best known as challenging some of the company's policy positions.

This makes it possible to 'drill down' to academic research papers and official documents produced by government regulators and agencies on topics ranging from European chemicals regulation to health concerns about the use of perfumes in laundry products.

"Accounting Oversight Board Can't Find Workers, Cuts Budget," SmartPros, January 3, 2005 --- http://www.smartpros.com/x46423.xml 

The U.S. accounting watchdog has voted to cut its 2005 budget by more than 10 percent, to $136.1 million, mainly because of difficulties in hiring workers.

The Public Company Accounting Oversight Board also said it may consider raising salaries in order to attract workers as competition for experienced auditors intensifies.

Thursday's budget cut comes just two months after the board approved a $152.8 million budget for 2005 amid expectations that it would start the year with 300 employees. Instead, the audit-oversight board will begin the new year with 262 staffers, reducing the chances of meeting projections for 450 employees by the end of 2005.

The nonprofit board was created by Congress 2 1/2 years ago in the aftermath of a series of corporate accounting scandals. It has been seeking to add to its work force as it picks up its routine inspections. The board plans to conduct annual inspections of firms that audit more than 100 public companies, and to inspect the smaller accounting firms at least once every three years.

The oversight board is funded through fees levied on auditing firms and public companies.

The audit-oversight board said that, even with less money and fewer workers than projected, it will be able to meet the requirements of the Sarbanes-Oxley Act on corporate reform.

A Politically Divided SEC:  Why We Can't Trust Government Agencies to Protect US from Big Business

Of all the lawsuits, one filed against Mr. Winnick last October in federal court in Manhattan holds special significance. J. P. Morgan Chase and other leading banks are seeking $1.7 billion in damages from Mr. Winnick and other Global Crossing executives, contending that the group engaged in a "massive scam" to "artificially inflate" the company's performance to secure desperately needed loans. Mr. Winnick, whose lawyers dispute the accusations, declined to be interviewed for this article.  Among other things, the suit refocuses attention on exactly what Mr. Winnick knew about his company's finances during times when it was borrowing heavily and he was selling hundreds of millions of dollars in stock. It also outlines a troubling series of meetings he held with Mr. Lay and other Enron executives just months before their company crumpled.
Timothy O'Brian, "A New Legal Chapter for a 90's Flameout," The New York Times, August 15, 2004 --- http://www.nytimes.com/2004/08/15/business/yourmoney/15win.html 

"SEC Won't Charge, Fine Global Crossing Chairman:  Agency's Donaldson Goes Against Staff, Noting Winnick's Nonexecutive Role," by Deborah Solomon, The Wall Street Journal, December 13, 2004; Page A1 --- http://online.wsj.com/article/0,,SB110290635013498159,00.html?mod=todays_us_page_one 

The Securities and Exchange Commission won't file civil securities charges against former Global Crossing Ltd. Chairman Gary Winnick over disclosure violations or impose a $1 million fine, according to people familiar with the matter.

The action came despite objections from the SEC's two Democratic members and represents a rare reversal by the commission of its enforcement staff. It also caps a lengthy investigation of Global Crossing, the former Wall Street darling that helped set off a gold rush to capitalize on the Internet boom of the late-1990s.

. . .

The SEC had been expected to fine Mr. Winnick $1 million for failing to properly disclose a series of transactions undertaken by the telecom company, and he had tentatively agreed to pay that sum as part of a settlement agreement. But at a closed-door commission meeting last week, SEC Chairman William Donaldson and his two fellow Republican commissioners, Cynthia Glassman and Paul Atkins, opposed a staff recommendation to charge Mr. Winnick. Mr. Donaldson expressed concern that Mr. Winnick was a nonexecutive chairman and hadn't signed off on the inadequate disclosure, these people said.

This is what happens when Republicans win elections (and I'm a Republican)
The SEC is facing resistance from two Republican commissioners over the stiff fines it has been imposing on companies.
Deborah Solomon, "As Corporate Fines Grow, SEC Debates How Much Good They Do," The Wall Street Journal, November 12, 2004 --- http://online.wsj.com/article/0,,SB110021198122471832,00.html?mod=home_whats_news_us 
Bob Jensen's threads on why white collar crime pays (even when you get caught) are at http://www.trinity.edu/rjensen/FraudConclusion.htm#CrimePays 

Forget it!  The DC part of Washington DC means Donate Cash
"SEC Loves NYSE," The Wall Street Journal,  December 6, 2004; Page A14

Never underestimate the ability of a bureaucracy to wiggle backward. After many months of heavy breathing, the Securities and Exchange Commission is about to take stock trading back several decades. If you're thinking: Hmmm, this will help the New York Stock Exchange, you're right.

Back in February, the SEC proposed an overhaul of the national market system, called Reg NMS. The idea was to modernize an increasingly laborious and inefficient structure put in place in the 1970s. The main driver for reform, especially from institutional investors who often trade on behalf of smaller investors, was the trade-through rule.

So where was Levitt before Spitzer did his job?  While heading up the SEC, Levitt always seemed willing to take on the CPA firms, but he treaded lightly (really did very little) while the financial industry on Wall Street ripped off investors bigtime.  It never ceases to amaze me how Levitt capitalizes on his failures.
Forget Enron, WorldCom or mutual funds. The crisis enveloping the insurance industry is "the scandal of the decade, without a question" and "dwarfs anything we've seen thus far."
Arthur Levitt as quoted by SmartPros, October 25, 2004 --- http://www.smartpros.com/x45590.xml 
Bob Jensen's threads on insurance frauds are at http://www.trinity.edu/rjensen/fraudRotten.htm#MutualFunds 

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

The executives who gave their external auditors low grades don't rate so high themselves!

"Few Audit Committees Are Implementing Key Practices, According to Report," AccountingWeb --- December 1, 2004 --- http://www.accountingweb.com/cgi-bin/item.cgi?id=100158 

AccountingWEB.com - Dec-1-2004 - As audit committees struggle implementing the requirements of Sarbanes-Oxley, fewer than one-third implement a majority of practices that lead to higher ratings of the financial audit process, according to the J.D. Power and Associates 2004 Audit Committee Best Practices Report(SM) released this week.

The report is a comprehensive, independent study of audit performance in the wake of the Sarbanes-Oxley Act of 2002, which established new compliance and procedural requirements for corporate financial accountability of public companies. The report, based on interviews with 1,007 audit committee chairs and 944 chief financial officers, examines audit committee practices and confidence levels in the accounting industry.

"Audit committee chairs are now feeling the weight of increased accountability while experiencing some confusion regarding what compliance exactly looks like," said Ron Conlin, partner at J.D. Power and Associates. "This has translated into a good deal of stress. Audit committees are seeking information that will assist them in strengthening their oversight process and improve committee effectiveness. However, understanding which practices work best continues to be a challenge for audit committees."

The report documents that while audit committees have improved compared to 2003, significant challenges remain.

Several practices being performed by audit committees are directly linked to higher performance ratings of audit firms and increased industry confidence. Examples of best practices include:

More frequent meetings between the audit committee and the external auditor improve performance ratings by the audit chair. External auditors who meet with the audit chair seven or more times per year receive the highest ratings. Most audit committees meet five or more times annually with the external auditor. Compared to 2003, audit committees of both small and large companies are meeting more frequently.

Excluding management from some meetings also increases ratings with the audit process. The majority of companies that meet four to six times annually frequently exclude management.

Audit committee chairs who spend between 16 and 20 hours annually attending audit committee meetings rate the audit experience higher than those spending fewer than 16 hours. Conversely, ratings begin to drop once the number of hours attending audit committee meetings exceeds 20. "Understanding audit committee practices is essential because the best practices, when applied, result in higher ratings of the audit process, which directly relates to confidence in the accounting industry," said Conlin. "More than 86 percent of respondents who give high ratings to their audit firms also say they are extremely or very confident in the accounting industry. However, only 31 percent of those who give their audit firms low ratings record the same levels of confidence in the industry." The J.D. Power and Associates Audit Committee Best Practices Report is based on the experiences and opinions of 1,951 audit committee chairs and chief financial officers at SEC-listed companies who were surveyed between July and October 2004. 

The report can be purchased at www.jdpower.com/auditreport 

Enhancing Auditors’ Capabilities to Detect Fraud
EY Faculty Connection
Fall 2005 --- http://www.ey.com/global/content.nsf/US/EY_Faculty_Connection_(Issue_11)  

SAS 99 (AU 316) states, “The auditor has the responsibility to plan and to perform the audit to provide reasonable assurance about whether the financial statements are free of material misstatement, whether caused by error or fraud.” PCAOB Chairman William McDonough stated it differently when asked the question, “How do you respond to auditor’s insistence that it isn’t their job to detect fraud? He replied, “We have a very clear view that it is their job. If we see fraud that wasn’t detected and should have been, we will be very big on the tough and not so big on the love.” As I read these two quotes, it appears to me that, the bar is being raised. Regulators, audit committees, management, and auditors all play a vital role in preventing or detecting fraud . As educators, how can we do a better job of training tomorrow’s business leaders–and especially auditors--to detect material fraud?

Over my career, I have both taught auditing and have been an expert witness in numerous cases where auditors were sued for negligence because of not detecting fraud. In one such case, the fraud had been going on for 16 years and the perpetrator has embezzled over 10% of the company’s assets. Several times, while conducting annual audits, the auditors had identified real fraud symptoms but had dismissed them based on client representations. In another case, auditors sent confirmations to addresses that were really only rental mail boxes that appeared to be physical addresses only to have the perpetrators fly to the location, complete the confirmations and confirm that everything was okay. In a multi-billion dollar case, it was alleged that auditors not only saw fraud symptoms but must have been participants in the fraud not to recognize those symptoms.

Detecting and proving fraud are extremely difficult. Recent cases where CEOs have been acquitted attest to the difficulty of proving fraud. However, given that auditors may be held liable for failing to detect material fraud, it is incumbent upon all of us who prepare tomorrow’s auditors to make them better fraud detectors.

People who commit fraud do not fit the profile of typical criminals. Instead, they look just like us. They have rationalized committing fraud either because (1) they lack basic ethical values, (2) they have basic ethical values but don’t know how to translate those values to business settings and decisions, (3) they know how to translate their ethical values to business settings but they lack the ethical courage to make the right decision even when it is costly or (4) they work in an environment where ethical leadership is absent and they are taught to be dishonest through unethical modeling and labeling. They have also perceived an opportunity to commit and conceal the dishonest acts and, most often, they have some kind of firm or individual pressure that is motivating them to take advantage of the perceived opportunity and to rationalize the dishonesty.

Given that most fraud perpetrators look like us and are first-time offenders, how can auditors better detect fraud? I believe that both the firms and educators must do a better job in teaching fraud detection. Most of our students and firms’ young staff members wouldn’t recognize a fraud if it hit them between the eyes. Here are some ways educators can better teach our students fraud detection techniques:

We should use major fraud cases to teach accounting principles throughout our curriculum. Students will understand accounting principles better when they see how they have been abused. For example, the difference between assets and expenses can be effectively taught using WorldCom. Our students need to know that throughout their careers they will be exposed to fraud, as an auditor, consultant, coworker or victim. Fraud is now so common that all of us will witness it in one form or another. We must force our students to face ethical and fraud dilemmas in every course in our accounting curricula. Most good textbooks now contain ethical dilemmas or cases related to the subject matter being taught. Unfortunately, most professors don’t use these or other fraud and ethics cases. Students should be exposed to and learn to recognize potential conflicts of interest, fraudulent behavior, illegal activities and “shrewd” business practices that push the limits of propriety.

We can teach a dedicated fraud course where students learn why and how fraud is committed and how to prevent, detect and investigate fraud. Regardless of the careers our students choose, learning how to skeptically examine records, conduct better interviews and use technology to detect fraud are skills that will be valuable to them.

In our classes, we should use pedagogical tools such as inquiry, data mining and brainstorming that our students will be using as professionals to detect fraud.

To establish a proper tone, our business schools should establish a code of ethical conduct and invite all students, staff, and faculty to pledge to honor it. The code should be discussed and made a prominent part of our business schools.

The firms, too, must become better in training their auditors to detect fraud. They must spend time in both separate and integrated training sessions and on the job teaching auditors about deception, the nature of fraud, how to conduct fraud risk assessments, how to analyze journal entries for fraud, common fraud schemes, how to mine data, how to better conduct interviews and brainstorming sessions, and in working through fraud case studies. Auditing firms must continuously reinforce the fact that they are in the business of detecting fraud, regardless of what the standards say. The purpose of an audit has come full circle. The first edition of the Montgomery auditing text, published in 1917, states that an audit had three objectives: (1) detection of fraud, (2) detection of technical errors, and (3) detection of errors in principle. Through a series of frauds (e.g. McKesson Robbins, etc.) and issuance of new standards, the responsibility to detect fraud evolved from “…the ordinary examination…is not designed and cannot be relied upon to disclose defalcations and other similar irregularities” (SAP 1) to “…an audit gives consideration to the possibility of fraud” (SAP 30) to “…auditors must plan the audit to search for material errors or irregularities” (SAS 16) to “…auditors must design the audit to provide reasonable assurance of detecting material fraud,” (SAS 53) to “the auditor must plan and perform the audit to obtain reasonable assurance about whether the financial statements are free from material misstatement whether caused by error or fraud (SAS 82 & 99) to “…it is their job to detect fraud.” (William McDonough, PCAOB)

Given this renewed responsibility, both educators and firms must be more diligent and pro-active in teaching students and employees how to detect fraud. We can no longer say it is someone else’s responsibility. Not doing so will result in increased regulation, litigation, and lesser esteem and respect for our profession.

W. Steve Albrecht
Professor of Accounting
Brigham Young University

Links to Bob Jensen’s fraud documents --- http://www.trinity.edu/rjensen/Fraud.htm

"Accounting Education: Response to Corporate Scandals," by Pierrel L. Titard, Robert L. Braun, and Michael J. Meyer, Journal of Accountancy, November 2004, pp. 59-65 --- http://www.aicpa.org/pubs/jofa/nov2004/titard.htm 

IN THE WAKE OF THE CORPORATE SCANDALS CAUSED by Enron, WorldCom and others, the CPA profession has taken numerous steps to turn crisis into opportunity. In particular colleges, universities and their accounting faculties have changed their course offerings and other aspects of the accounting program to better equip students to cope with the ethical challenges of the accounting profession. 

AVAILABLE DATA SUGGEST ENROLLMENT IN accounting programs around the country is stable and there was no immediate exodus of students following the scandals. Individual schools have addressed the new professional environment head on with new course offerings, real-life case studies, increased emphasis on ethics and guest speakers at seminars and lectures.

ACCOUNTING INSTRUCTORS SAY THE SCANDALS have helped them emphasize to students the importance of accounting. The attitudes of students themselves have not changed significantly in the postscandal period. In general, the more students knew about what had taken place the more positive their attitude toward accounting.

TO CAPITALIZE ON THESE CHANGES, SCHOOLS NEED to make introductory courses more relevant to the current business climate to encourage more students to major in accounting. Instructors need to offer students at all levels the opportunity to explore the social, political and ethical implications of accounting decisions.

AS STUDENTS GRADUATE AND TAKE JOBS IN INDUSTRY or public practice, employers need to reinforce the ethics lessons students learn in school in the workplace. This can be done through employer-sponsored ethics workshops and by making it clear that CPAs are free to raise questions when they suspect possible wrongdoing.

I have mixed feelings about convicts exploiting their misdeed experiences for huge lecture and speaking fees.  They often do have valuable and inspirational speeches and recorded material, but should they be making huge fees after serving time for ripping off the public.  In fairness, some to some pro bono presentations for schools, but in most instances their fees are enormous for speeches and lectures.

"After Serving Time, Executives Now Serve Up Advice," by Christopher S. Stewart, The New York Times, June 1, 2004 --- http://www.nytimes.com/2004/06/01/business/01convict.html

Corporate executives facing trials for misdeeds at work are grappling with the possibility of a long stretch in prison. But they can take comfort in the fact that business is booming for a few executives-turned-felons who have turned their stories into topics on the lecture circuit.

From a former finance executive to a lawyer who specialized in civil litigation, some white-collar criminals are getting paid several thousand dollars to talk about their crimes to business schools, professional associations and corporations.

"It's a powerful message," said Kellie McElhany, professor of corporate management at the Haas School of Business at the University of California, Berkeley. She has had Walter Pavlo, the former senior manager of collections at MCI who spent more than a year and a half in prison after he was convicted of wire fraud and money laundering, speak at the school's Center for Responsible Business.

"You actually get to see the consequences of poor ethical decision making," Professor McElhany said.

Gary Zeune, who runs Pros & Cons, a speaker agency in Columbus, Ohio, that specializes in former white-collar criminals, says demand has increased about 30 percent in the last year, helped by the prominent trials of executives like Martha Stewart and L. Dennis Kozlowski, the former Tyco chief executive.

At the same time, a growing number of executives appear to be willing to talk about their misdeeds. Mr. Zeune gets phone calls, e-mail messages and letters almost every other week from former criminals, he said, more than double the number of requests he received two years back. Speakers at his agency are paid $1,000 to $3,000.

But the phenomenon is unlikely to last, said Toby Bishop, president and chief executive of the Association of Certified Fraud Examiners, who has used convicted executives to conduct training and to lecture.

Corporate crime is "just a hot topic now," he said. "And in two or three years, if there are no more corporate scandals, it will be replaced by something else."

But for now, white-collar criminals are in demand. Mr. Pavlo of MCI is one of Mr. Zeune's most popular speakers. Since his release in 2003, he has earned more than $30,000.

In his speeches, Mr. Pavlo talks about how he devised a complicated accounting scheme with an outside partner that yielded $6 million in stolen customer money in six months, and he describes what he was thinking at the time of the crime.

This year, he says, he could earn $150,000 to $200,000, charging as much as $5,000 for a speech.

Andrea Bonime-Blanc, senior vice president and chief ethics and compliance officer at the New York office of Bertelsmann Media Worldwide, hired Mr. Pavlo in March for a quarterly executive meeting she holds on the topic of ethics. While it was the first time she had hired a former convict, she said it went over very well.

Karen Bond, a lawyer in Ohio who served 38 months for interstate securities fraud, has talked widely in the media about Martha Stewart's conviction for lying about her sale of ImClone Systems stock. Her speaking run, however, may be short-lived. A spokesman for Ms. Bond, Somer Stephenson of Stephenson Consulting Group in Califon, N.J., said she was no longer available, citing probation issues. Ms. Bond did not return repeated phone calls for comment.

Mark Morze was convicted in the late 1980's of stock fraud, wire fraud and tax evasion while an executive at the carpet cleaning company ZZZZ Best. After emerging from prison in 1994, he hit the speaker's circuit and says he has consistently made $60,000 to $80,000 a year. Mr. Morze is a regular at the Graziadio School of Business at Pepperdine University, where his message is deterrence.

The presence of corporate felons on the talk circuit has been reported by Crain's New York Business.

Public speaking is not a real option for most white-collar criminals, Mr. Zeune said. "You have to have a compelling story and take responsibility for what you did, which is something a lot of criminals won't do."

Even for the few who find speaking jobs, success can be elusive.

David London, who served 11 months for fraud committed while he was chief executive of the former People's Bank of Unity in Pennsylvania, worked as a clerk at a local medical center and did general labor for a film studio after he was released in 1998. Today, he is a speaker with Mr. Zeune's group, but he gives only a handful of lectures a year, making pocket money. He lives in the extra room of an old friend's house and, to make ends meet, he works as a mortgage broker and officiates at college and high school sporting events.

"I can't get a decent job anymore," Mr. London, 61, said. "All my life was in banking, over 30 years. Even if I tried to get a night job at a hotel in auditing, I wouldn't be able to get it. "

June 9, 2004 reply from Ed Scribner [escribne@NMSU.EDU]

Bob,

At least, as I understand it, Barry Minkow donates his speaking fees to restitution fund for the victims of ZZZZBest.

Ed

June 9, 2004 reply from Bill Dent [billdent@UTDALLAS.EDU]

Ed:

I am not sure "donates" is the appropriate term. According to Knapp in his book, Contemporary Auditing--Real Issues and Cases, the federal court ordered Mr. Minkow to pay the victims of the ZZZZ Best fraud $26 million.

Bill

Accounting Education Shares Some of the Blame

Enhancing Auditors’ Capabilities to Detect Fraud
EY Faculty Connection
Fall 2005 --- http://www.ey.com/global/content.nsf/US/EY_Faculty_Connection_(Issue_11)  

SAS 99 (AU 316) states, “The auditor has the responsibility to plan and to perform the audit to provide reasonable assurance about whether the financial statements are free of material misstatement, whether caused by error or fraud.” PCAOB Chairman William McDonough stated it differently when asked the question, “How do you respond to auditor’s insistence that it isn’t their job to detect fraud? He replied, “We have a very clear view that it is their job. If we see fraud that wasn’t detected and should have been, we will be very big on the tough and not so big on the love.” As I read these two quotes, it appears to me that, the bar is being raised. Regulators, audit committees, management, and auditors all play a vital role in preventing or detecting fraud . As educators, how can we do a better job of training tomorrow’s business leaders–and especially auditors--to detect material fraud?

Over my career, I have both taught auditing and have been an expert witness in numerous cases where auditors were sued for negligence because of not detecting fraud. In one such case, the fraud had been going on for 16 years and the perpetrator has embezzled over 10% of the company’s assets. Several times, while conducting annual audits, the auditors had identified real fraud symptoms but had dismissed them based on client representations. In another case, auditors sent confirmations to addresses that were really only rental mail boxes that appeared to be physical addresses only to have the perpetrators fly to the location, complete the confirmations and confirm that everything was okay. In a multi-billion dollar case, it was alleged that auditors not only saw fraud symptoms but must have been participants in the fraud not to recognize those symptoms.

Detecting and proving fraud are extremely difficult. Recent cases where CEOs have been acquitted attest to the difficulty of proving fraud. However, given that auditors may be held liable for failing to detect material fraud, it is incumbent upon all of us who prepare tomorrow’s auditors to make them better fraud detectors.

People who commit fraud do not fit the profile of typical criminals. Instead, they look just like us. They have rationalized committing fraud either because (1) they lack basic ethical values, (2) they have basic ethical values but don’t know how to translate those values to business settings and decisions, (3) they know how to translate their ethical values to business settings but they lack the ethical courage to make the right decision even when it is costly or (4) they work in an environment where ethical leadership is absent and they are taught to be dishonest through unethical modeling and labeling. They have also perceived an opportunity to commit and conceal the dishonest acts and, most often, they have some kind of firm or individual pressure that is motivating them to take advantage of the perceived opportunity and to rationalize the dishonesty.

Given that most fraud perpetrators look like us and are first-time offenders, how can auditors better detect fraud? I believe that both the firms and educators must do a better job in teaching fraud detection. Most of our students and firms’ young staff members wouldn’t recognize a fraud if it hit them between the eyes. Here are some ways educators can better teach our students fraud detection techniques:

We should use major fraud cases to teach accounting principles throughout our curriculum. Students will understand accounting principles better when they see how they have been abused. For example, the difference between assets and expenses can be effectively taught using WorldCom. Our students need to know that throughout their careers they will be exposed to fraud, as an auditor, consultant, coworker or victim. Fraud is now so common that all of us will witness it in one form or another. We must force our students to face ethical and fraud dilemmas in every course in our accounting curricula. Most good textbooks now contain ethical dilemmas or cases related to the subject matter being taught. Unfortunately, most professors don’t use these or other fraud and ethics cases. Students should be exposed to and learn to recognize potential conflicts of interest, fraudulent behavior, illegal activities and “shrewd” business practices that push the limits of propriety.

We can teach a dedicated fraud course where students learn why and how fraud is committed and how to prevent, detect and investigate fraud. Regardless of the careers our students choose, learning how to skeptically examine records, conduct better interviews and use technology to detect fraud are skills that will be valuable to them.

In our classes, we should use pedagogical tools such as inquiry, data mining and brainstorming that our students will be using as professionals to detect fraud.

To establish a proper tone, our business schools should establish a code of ethical conduct and invite all students, staff, and faculty to pledge to honor it. The code should be discussed and made a prominent part of our business schools.

The firms, too, must become better in training their auditors to detect fraud. They must spend time in both separate and integrated training sessions and on the job teaching auditors about deception, the nature of fraud, how to conduct fraud risk assessments, how to analyze journal entries for fraud, common fraud schemes, how to mine data, how to better conduct interviews and brainstorming sessions, and in working through fraud case studies. Auditing firms must continuously reinforce the fact that they are in the business of detecting fraud, regardless of what the standards say. The purpose of an audit has come full circle. The first edition of the Montgomery auditing text, published in 1917, states that an audit had three objectives: (1) detection of fraud, (2) detection of technical errors, and (3) detection of errors in principle. Through a series of frauds (e.g. McKesson Robbins, etc.) and issuance of new standards, the responsibility to detect fraud evolved from “…the ordinary examination…is not designed and cannot be relied upon to disclose defalcations and other similar irregularities” (SAP 1) to “…an audit gives consideration to the possibility of fraud” (SAP 30) to “…auditors must plan the audit to search for material errors or irregularities” (SAS 16) to “…auditors must design the audit to provide reasonable assurance of detecting material fraud,” (SAS 53) to “the auditor must plan and perform the audit to obtain reasonable assurance about whether the financial statements are free from material misstatement whether caused by error or fraud (SAS 82 & 99) to “…it is their job to detect fraud.” (William McDonough, PCAOB)

Given this renewed responsibility, both educators and firms must be more diligent and pro-active in teaching students and employees how to detect fraud. We can no longer say it is someone else’s responsibility. Not doing so will result in increased regulation, litigation, and lesser esteem and respect for our profession.

W. Steve Albrecht
Professor of Accounting
Brigham Young University

Links to Bob Jensen’s fraud documents --- http://www.trinity.edu/rjensen/Fraud.htm

"Accounting Education's Role in Corporate Malfeasance: It's Time for a New Curriculum!" , IMA Strategic Finance, April 2004.  The link for Strategic Finance is at http://www.imanet.org/ima/sec.asp?TrackID=&DID=65&CID=39 
See SmartPros --- http://www.smartpros.com/x42801.xml 

April 2004 (Strategic Finance) — The white-hot glare of media, public, legislative, and legal scrutiny has created media frenzy over the corporate malfeasance of several large, very successful firms. The finger pointing, for example, among Enron, Arthur Andersen (its auditor-consultant), and politicians attempting to reap political advantage has become fertile ground for ongoing discussions over the cause and effect of the malfeasance.

If we are looking for a primary contributing cause of corporate malfeasance at firms such as Enron, Equity Funding, WorldCom, Sunbeam, Arthur Andersen, and HealthSouth, we need look no further than the classrooms of college and university accounting programs that have not significantly adapted their methods of instruction or approach to accounting and management education over the last 50-60 years.

Yes, delivery of instruction has evolved from blackboards to overhead transparencies to PowerPoint slides to Web-based tutorials. Course content and classes offered, however, remain clustered around a traditional accounting core with minimal excursion into other disciplines or ethics.

Accounting programs continue to use the same pedagogical approach that allowed them to be successful until the early 1990s. Demand for students remained strong. "Big 8," now "Big 4," accounting firms continued to hire entry-level auditors and lavish resources on programs that maintained adherence to the "eye-of-the-needle" approach for accounting higher education. Accounting programs were expected to produce an entry-level professional capable of success on state-administered Certified Public Accountant examinations-the "eye of the needle." The CPA exam has developed a strong following as the entrylevel professional examination capable of helping new graduates gain employment with public accounting firms, but it no longer assures ascension to chief financial officer (CFO) status or higher levels of a firm's management.

The passage of the 150-hour rule (5th year) in accounting to sit for the CPA exam was intended to provide for a broadened management education experience for accounting graduates. Instead, accounting programs and faculty in most programs co-opted the 150-hour rule to require even more accounting courses that enabled many of the 40,000 annual accounting graduates to focus with laser precision on completing the CPA exam to the exclusion of information technology, ethics, finance, and related management education courses. It's increasingly clear, however, that these excluded courses would have produced a more diverse entry-level employee capable of moving seamlessly into the profession and would have provided the educational background and diversity for him/her to gain a view of business as a whole rather than just the accounting silo.

Forty-three states have adopted the rule that requires 150 hours of college/university courses before a candidate can sit for the CPA exam. California, a notable exception, has not passed 150-hour legislation.

In effect, the 150-hour rule is still viewed at many colleges and universities as a "full-employment act" for accounting faculty because most programs added an extra year of accounting courses rather than broadening future graduates' perspectives through more classes in technology, ethics, finance, and management. Some programs diversified their program content, but not many!

It isn't surprising that the successful completion of the CPA exam and the accompanying rewards fostered the view in new accounting employees that their future success depended on continued adherence to a textbook mentality of accounting similar to that required to pass the CPA exam and become auditors -- "the eye of the needle." The idea of achieving a better, broader understanding of the business environment is alien to most accounting graduates. Too many accounting faculties dismiss economics, marketing, management, and ethics, for example, as nonessential components of a successful accounting student model.

Yet the audit (assurance services) function is the only one of the three major accounting business functions that requires state licensing; i.e., auditing is a legislationgranted monopoly. The other two functions, tax and consulting, require no state or federal licensing and, therefore, are subject to market-based pressures from non-CPA firms. Many CPA firms have split off these operations through either a public offering or separate partnership entities and ownership.

Assurance services are under tremendous market pressure because the services provided by this part of a CPA firm are viewed as a commodity by those entities needing the service, and, hence, an audit by one CPA firm is as good as an audit from a competing firm. CPA firms are scrambling to niche themselves within the assurance serai vices area as a way to gain an advantage in Rf their bidding for client work.

In essence, accounting firm employees become highly paid "prisoners" of a mind-set and a work environment that preclude their efforts to engage and nurture the dynamic creative and critical thinking necessary for a global marketplace. Today's auditors too often fight the last audit "war" as the benchmark for their next audit. Classroom pedagogy contributes to the "prisoner" mentality in the sense that accounting students who strive to be creative, different, and think out of the box are quickly reined in and assured that the only successful accountant is a CPA.

Accounting Model Is Broken Accounting higher education has been warned repeatedly that the current model is broken, significant change is necessary, and a new education model, consistent with global market expectations for their student products, must be developed. This new model is required if accounting education wants to continue to achieve the business community's respect and to be perceived as adding value to the profession. Here are a few examples of those warnings:

1. "There is little doubt that the current content of professional accounting education, which has remained substantially the same over the past 50 years, is generally inadequate for the future accounting professional. A growing gap exists between what accountants do and what accounting educators teach.... Accountants who remain narrowly educated will find it more difficult to compete in an expanding profession." ["Future Accounting Education: Preparing for the Expanding Profession," American Accounting Association's (AAA) Committee on Future Structure, Content, and Scope of Accounting Education, 1986]

2. "Perspectives on Education for Success in the Accounting Profession" [Big 8 White Paper, 1989], reflected a growing concern about the current and future state of accounting education. In fact, the then Big 8 public accounting firms anted up $5 million to help create the Accounting Education Change Commission [AECC] to redirect the focus of accounting education. The AECC's efforts, while well intended, had little long-lasting impact.

3. What Corporate America Wants in Entry-Level Accountants [a joint research project of the Institute of Management Accountants (IMA) and Financial Executives International (FEI), 1994] found widespread dissatisfaction with college and university accounting curricula in terms of preparation for successful careers in corporate America. Knowledge, skills, and abilities (KSAs) necessary for future success by entry-level accountants were identified and discussed.

4. "The primary problem is that faculty skills are not aligned with the rapidly changing needs of business.... Over time, business practice has advanced rapidly (e.g., TQM, re-engineering, cycle time reduction, diversity in the work force, customer satisfaction incentives, global strategy, and managing technology). Although school and faculty competencies have advanced, the gap between practice and academic research and teaching has widened. The lack of business interaction, changing technologies, aging faculty, and shortage of incentives to change have inhibited faculty initiative for change that is necessary to keep pace with a rapidly changing environment. Faculty should be leading the next generation of industry knowledge and practice, but, in some schools, this is not the case." [A Report of the AACSB Faculty Leadership Task Force, 1995-1996, American Assembly of Collegiate Schools of Business (AACSB)]

5. "In recent years, various stakeholders have voiced numerous concerns that business and accounting education have not changed with the changing demands of the market for graduates.... Eikewise, the changing marketplace and regulator environment for accounting services have created demands for different emphases in accounting education. The education that served past graduates will not prepare today's graduates for the demands of the twenty-first century." ["The Future Viability of Accounting Education, Report of the Changing Environment Committee," AAA, July 15, 1998]

6. Accounting Education: Charting the Course Through a Perilous Future [A joint project of AAA, American Institute of Certified Public Accountants (AICPA), IMA, and five public accounting firms -- Arthur Andersen, Deloitte & Touche, Ernst & Young, KPMG, and PricewaterhouseCoopers, 2000] The study states, ". . . accounting education today is plagued with many serious problems and ... if those problems are not seriously addressed and overcome, they will lead to the demise of accounting education. Consider the following facts:

* "The number and quality of students electing to major in accounting is decreasing rapidly. Students are telling us by their choice of major that they do not perceive an accounting degree to be as valuable as it used to be or as valuable as other business degrees.

* "Both practicing accountants and accounting educators, most of whom have accounting degrees, would not major in accounting if pursuing their education over again.

* "Accounting leaders and practicing accountants are telling us that accounting education, as currently structured, is outdated, broken, and needs to be modified significantly."

Each of the above research studies, and there are many others, sounded a clarion call for accounting faculty and programs to adapt their curricula to meet current and future marketplace demands. Each study reflects the market shift away from traditional accounting jobs and toward a more general industry expectation for employment and career development. The studies provide a wealth of information for programmatic change. Each study, and other similar ones, should be required reading for all business and accounting leaders as they identify the accounting program graduates that best meet their business and accounting needs.

It's clear that Enron and Arthur Andersen did not exercise due diligence in the hiring of employees with sufficient knowledge, skills, and abilities; a rich and diverse management education background; or a strong ethics mentality when the firms made their entry-level hiring decisions. Also, before those employees were hired, the two firms, and many others like them, did not interact with accounting programs and faculty to ensure that the profession received graduates with diverse academic backgrounds who would become valued-added employees and contributors to the firms' economic well-being.

The integrity of the accounting profession has been called into question because of the Enron and Arthur Andersen accounting debacle. If accounting education expects to remain a major player in the professional development of entry-level employees, it must accept its share of the Enron, Arthur Andersen, and WorldCom failures, for example, and move quickly and positively to change the accounting education paradigm.

The Institute of Management Accountants has been actively engaged in numerous research studies (see www.imanet.org for listing) focusing on accounting education and the related KSAs necessary for long-term benefit to the accounting profession. The IMA strongly supports a diverse, management education curriculum alternative at colleges and universities to ensure that entry-level professionals start their careers with a rich and varied academic history. This coursework includes accounting technical abilities coupled with broad-based management education courses. IMA believes this will better prepare the future professional to be a successful accountant and also will provide sufficient background in related management education to (1) help management handle internal management decisions from a professional and ethical perspective and (2) develop the skill sets to move more quickly into management of the firm.

IMA's Vision IMA's vision [is] for the development of an entry-level professional who, at the completion of four or five years of academic preparation, can move easily into a value-added environment immediately. Pursuit of certification is important and beneficial to accounting professionals' careers, but it can't be allowed to become a hindrance to the development of a well-rounded professional accountant capable of detecting and solving corporate malfeasance prior to the disasters noted earlier. IMA believes this curriculum model is consistent with developing strong academic preparation for an entry-level professional and adds value to the young professional's portfolio of necessary KSAs.

Can the profession, including accounting education, react in a swift, positive, resolute manner to burnish its tarnished image? This clarion call may be the last opportunity before self-regulation is replaced by governmental oversight.

The Public Company Accounting Oversight Board (PCAOB) created by Sarbanes-Oxley reflects increased governmental oversight possibilities. PCAOB isn't perfect and, in fact, perpetuates the current accounting education model's focus on Generally Accepted Accounting Principles (GAAP) and accounting profit rather than economic realities tied to return on assets and cash flow.

"From the standpoint of public policy on modern capital markets, this lets the accountants off rather easily. The purpose of capital markets is to direct scarce capital to its highest uses. The highest uses depend on economic profitrates of return on assets -- not on accounting profits. Yet, the Sarbanes-Oxley Act that established the Accounting Oversight Board also enshrined EPS and GAAP more firmly than ever. The act puts impediments to revealing economic-profit numbers such as.. .cash or.. .EVA." (Wall Street Journal, "Economic Profit vs. Accounting Profit," Robert L. Bartley, June 2, 2003, p. A17)

Accounting education is at its best when it's at the leading edge of what is practiced in industry. The current issues facing the profession will reshape the practice of public accounting as well as industrial, governmental, and nonprofit accounting. Accounting education must take on the challenge and integrate throughout the curriculum the concepts introduced by Sarbanes-Oxley. Creation of the PCAOB must be viewed as a preemptory effort, by congressional fiat, to fix the alleged wrongs in the accounting profession.

The profession has the right to demand current market competencies and strong, current portfolios from colleagues in academic programs. But it also has the responsibility to help accounting education and educators through meaningful support, ensuring currency of academics and their programs. It is particularly beneficial to academic programs to receive interaction and insight into the practice of management accounting, financial management, and information systems/technology. IMA believes an alliance among IMA, practitioners, and academic programs/educators can help achieve this important goal for much needed academia leadership.

Is increased governmental control to be the legacy of current accounting professors and their programs? That would be most unfortunate for the profession and the users of accounting information.

-- A. Keith Russell; Carl S. Smith

Reply from Bob Jensen on April 21, 2004

It is interesting that the IMA published this article in the IMA's Strategic Finance journal.  The unspoken implication is that perhaps other business education disciplines, especially finance, are doing a better job than accounting in educating to prevent corporate malfeasance.  The opposite is the case.  Accountants have perpetrated their share of the modern-day corporate frauds, and CPA firm audits certainly have declined in quality.  But the majority of the perpetrators of corporate frauds and the Wall Street scandals in investment banking and trading were MBA graduates with almost no accounting education.  Even the infamous Andy Fastow at Enron had minimal exposure to accounting in his MBA concentration in finance at Northwestern University.

Indeed one might argue that the expansion of MBA courses in finance in rather innocent ways led to many of the corporate scandals and Wall Street fiascos of the 1990s.  Frank Partnoy points out that the MBA curriculum at the University of Pennsylvania's Wharton School in year 2002 had twenty specialized courses in finance that gave graduates like Andy Krieger the tools and temptations to commit crimes in brokerage houses and investment banks.  See Page 10 of Infectious Greed:  How Deceit and Risk Corrupted the Financial Markets (Henry Holt and Company, 1984).

That does not imply that Wharton finance professors were encouraging students to steal or even that they were showing them how to steal.  But they were teaching more and more about the intricacies and inefficiencies of capital markets (particularly OTC derivative markets) that graduates like Mike Milken, Allen Wheat, Andy Krieger used to exploit the widows and orphans.  

My point is that ethics was, and still is, far more neglected  in the finance curriculum than in the accounting curriculum.  If Wharton had introduced an elective course on Ethics of Capital Markets in an array of 21 elective courses in specialized finance courses, how popular do you think the new elective course would have been in the 1990s?  How popular do you think it would be today given a choice of learning about specialized financial skills for investment banking careers versus studying cases on ethics in capital markets?  Can you really imagine a Salomon or Morgan Stanley recruiter saying that it's the ethics course that made you a better prospect than a course on how to use intricate Contango swaps in currency trading?

I an a strong advocate in asserting that more stress needs to be placed upon ethics in education for careers and human relationships in general.  But I think introducing professionalism and ethics courses are not the route to take.  Instead, I support embedding ethics modules in our ever-increasing technical skills courses.  Students want and need the technical skills, and we should help meet these demands in accounting information systems courses, financial accounting courses, managerial accounting courses, and tax courses.  We should focus more on teaching how to learn for life and how to do research on technical as well as ethical topics.  

The problem of ethics has and always will be a combination of the tone and the top combined with temptations to falter.  The tone at the top went sour and temptations keep increasing.  It still pays to steal, and we need greater sanctions to prevent stealing.  The first of these is a greater reward for blowing the whistle.

An infectious greed seemed to grip much of our business community. ... It is not that humans have become any more greedy than in generations past.  It is that the avenues to express greed have grown so enormously.
Alan Greenspan, testimony before the Senate Banking Committee, July 16, 2002 

White collar crime pays big even if you get caught --- http://www.trinity.edu/rjensen/fraudconclusion.htm#CrimePays 

April 22, 2004 reply from Regel, Roy (Dr) [Roy.Regel@BUSINESS.UMT.EDU] 

Glen,

The Smartpros.com source has the article, but excluded the IMA's proposed Curriculum Model. It can be found on p. 4 of the lead article of the December 2003 issue of Strategic Finance-found in almost all university libraries.

Major subheadings of the curriculum model include:

General Education 48-60 hours

College of Business Curriculum 

1. Courses outside the COBA 27-33 
2. Courses within the COBA 27-33 (Some of these are considerably different from traditional curricula) 
3. Courses required for an accounting major- "Focus on technical proficiency sufficient to pass . . . CMA and CFM."

4. The 5th year-masters level- "12-15 accounting hours, with specific, intense focus on . . . CPA . . . "and "additional courses"

IMA members with a password can use this link to the article http://www.imanet.org/ima/sec.asp?TRACKID=&CID=1120&DID=1961 

Roy W. Regel, PhD, CPA, CMA 
Professor of Accounting 
The University of Montana - Missoula 406 243-5203

March 4, 2005 message from Groomer, S. Michael [groomer@indiana.edu]

Hi Bob.

Question -- sir. Are you aware of any courses being conducted that deal specifically with ethics implications for accountants/auditors. One of my Business Law colleagues ask me this question. Best I know, most of this kind of work occurs in UG Auditing or in a Master's level auditing course.

Hope all is well with you. Mike

Mike Groomer, Ph.D, CPA, CISA, CITP
Professor of Accounting and Information Systems
Kelley School of Business Indiana University
1309 East 10th Street Bloomington, IN 47405-1701

March 5, 2005 answer from Bob Jensen

A lot depends upon what you mean by “courses.”  Courses can range from videos to CPE training to college course modules to college courses on ethics in auditing to onsite training courses.

For reactions of accounting education to the implosion of Andersen, I suggest beginning with the following modules:

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

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

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

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

See the Dean of Wharton speak out on ethics --- http://www.globalagendamagazine.com/2005/patrickharker.asp

Wharton has probably done as much or more than any school on adding ethics modules --- http://www.wharton.upenn.edu/undergrad/topschools.html

Here are a few other suggestions for your friend:

For college courses enter “Ethics in Auditing” in the second box and “University” in the top box (don’t use quotation marks) and see the many links of interest that emerge from http://www.google.com/advanced_search?hl=en

Since the implosion of Enron, the Institute of Internal Auditors has changed its offerings on ethics training --- http://www.theiia.org/index.cfm?doc_id=883

Although the courses don’t necessarily deal with auditing per se, I always suggest visiting http://www.cfenet.com/splash/

These is a great deal on changed relationships between auditors and audit committees:
AICPA Video Courses --- https://www.cpa2biz.com/Stores/cpevideocourses.htm
Audit Committee Responsibilities After Sarbanes-Oxley

VHS/Manual or DVD/Manual — Sample video clip available
Fraud and the Financial Statement Audit: Auditor Responsibilities Under New SAS
VHS/Manual or DVD/Manual — Sample video clip available

AICPA's Annual Business Law Update See http://www.aicpalearning.org/palpha.asp I recommend going over the entire alphabetical listing at http://www.aicpalearning.org/profdevclass.asp The AICPA will also do onsite training --- http://www.aicpalearning.org/profdevclass.asp

ABLU

CPE (sometimes auditing is only a module of the course)

http://www.passonline.com/default.aspx

 

http://www.affiliateprofit.net/accounting/8/ethics-in-accounting.html

Corporate Responsibility We Help You Create Corporate Social Responsibility Policies www.Unity-Partners.com

Ethical Corporation cutting edge news & analysis in global corporate responsibility www.ethicalcorp.com

Ethics Theory and Issues Save Money on Books. Buy For Less on eBay. Bid Now! www.eBay.com

Outside Accounting

Code of Medical Ethics The Authority on Medical Ethics. AMA' s Complete Guide for Doctors.  www.amapress.com

"Two Siebel Executives Had Loose Lips, SEC Says:  Company Is the First One Charged Twice for Violating The "Fair Disclosure" Rule," by David Bank and Debora Solomon, The Wall Street Journal, June 30, 2004, Page C3 --- http://online.wsj.com/article/0,,SB108852785824650351,00.html?mod=technology_main_whats_news

Executives at Siebel Systems Inc. haven't learned when to keep quiet, the Securities and Exchange Commission says.

The SEC yesterday said Siebel and two of its senior executives violated the commission's fair-disclosure rules last year when the executives privately gave institutional investors a rosier picture of the company's prospects than had been disclosed publicly only days earlier, contributing to a one-day, 8% jump in Siebel shares.

Siebel is the first company to be charged twice with violating the SEC's Regulation FD (for "fair disclosure"), which was adopted in October 2000 to put small and large investors on an even playing field for access to corporate information. In November 2002, the San Mateo, Calif., maker of business software agreed to pay a $250,000 civil penalty, without admitting wrongdoing, after the SEC questioned remarks made by chairman and founder Tom Siebel at an investor conference.

Yesterday the SEC also charged Siebel with violating an agreement, stemming from the earlier violation, to adhere to the fair-disclosure rule. In another first, the agency charged Siebel with violating an SEC rule that requires companies to maintain procedures to ensure that information is disclosed to all investors in a timely fashion.

Because of the repeat nature of the alleged violations, the SEC asked a federal judge in New York to issue a permanent injunction barring Siebel from future violations. The SEC also asked for an injunction restraining the two executives from "aiding and abetting" violations of the rules. The agency also is seeking fines against Siebel and the two executives, but didn't specify the size of the possible fines.

The detailed complaint shows how some companies allegedly continue to try to bolster relationships with key investors by offering more information than they share with the broader public. The fair-disclosure rules, adopted in the wake of the tech-stock bubble, are intended to help small investors by combating a once-common practice whereby large investors or analysts would get market-moving information ahead of the public.

A Siebel spokesman declined to comment on the new charges.

The charges are the latest in a series of controversies that have swirled around Siebel and its brash founder, who stepped aside as chief executive earlier this year. In January 2003, Mr. Siebel canceled all stock options he had received since 1998 after criticism by some large investors about excessive executive compensation.

The latest complaint doesn't name Mr. Siebel personally. But the SEC claims Kenneth Goldman, Siebel's chief financial officer, and Mark Hanson, the company's former director of investor relations and now senior vice president for corporate development, in April 2003 selectively disclosed financial information in one-on-one meetings with institutional investors.

Early that month, Siebel said it wouldn't meet previous forecasts for first-quarter earnings. The company repeated a gloomy outlook in a conference call following the release of its earnings on April 23. Five days later, Mr. Siebel expounded on the pessimism in a speech at an investor conference. "With war, with famine, with disease, I mean it's like the apocalypse out there," the SEC quotes Mr. Siebel as saying.

Then, on April 30, according to the complaint, Messrs. Goldman and Hanson met with fund managers at Alliance Capital Management, a family of mutual and hedge funds, and attended a dinner hosted by Morgan Stanley. At the Alliance meeting, the SEC says, Mr. Goldman said Siebel's level of sales activity was "better," that the company had deals in its "pipeline" valued at more than $5 million, and that the pipeline was "growing."

The SEC complaint says two Alliance portfolio managers who hadn't held Siebel stock placed orders to purchase 114,200 shares immediately following the meeting, while markets were still open. A third fund manager, alerted by colleagues who had attended the meeting, by the next day had covered a short position of 108,200 shares -- a net change of 222,400 shares. The Alliance fund manager who held the short position had viewed Siebel as "kind of a small junky company," according to the SEC. An Alliance spokesman declined to comment.

According to the complaint, the two Siebel executives made similar remarks at the Morgan Stanley dinner that evening, attended by six institutional investors and Morgan Stanley employees. Early the next morning, the SEC says, Morgan Stanley sent e-mail to hundreds of individuals, detailing the "positive data points" from the dinner, including the growing pipeline. Two fund managers who attended the dinner bought Siebel shares the next morning.

That day, May 1, Siebel shares jumped 8% to $9.34, with trading volume nearly double the average daily volume for the previous 12 months, the SEC said.

As the stock rose, Jeffrey Amann, Siebel's general counsel, asked Mr. Goldman by e-mail whether additional disclosure was required. Mr. Goldman responded late that evening that he had "only reiterated exactly what was stated on the earnings call." Mr. Hanson told Mr. Amann rumors about Mr. Goldman's comments were false, the SEC says.

Continued in the article

"Accounting Education: Response to Corporate Scandals," by Pierrel L. Titard, Robert L. Braun, and Michael J. Meyer, Journal of Accountancy, November 2004, pp. 59-65 --- http://www.aicpa.org/pubs/jofa/nov2004/titard.htm 

IN THE WAKE OF THE CORPORATE SCANDALS CAUSED by Enron, WorldCom and others, the CPA profession has taken numerous steps to turn crisis into opportunity. In particular colleges, universities and their accounting faculties have changed their course offerings and other aspects of the accounting program to better equip students to cope with the ethical challenges of the accounting profession. 

AVAILABLE DATA SUGGEST ENROLLMENT IN accounting programs around the country is stable and there was no immediate exodus of students following the scandals. Individual schools have addressed the new professional environment head on with new course offerings, real-life case studies, increased emphasis on ethics and guest speakers at seminars and lectures.

ACCOUNTING INSTRUCTORS SAY THE SCANDALS have helped them emphasize to students the importance of accounting. The attitudes of students themselves have not changed significantly in the postscandal period. In general, the more students knew about what had taken place the more positive their attitude toward accounting.

TO CAPITALIZE ON THESE CHANGES, SCHOOLS NEED to make introductory courses more relevant to the current business climate to encourage more students to major in accounting. Instructors need to offer students at all levels the opportunity to explore the social, political and ethical implications of accounting decisions.

AS STUDENTS GRADUATE AND TAKE JOBS IN INDUSTRY or public practice, employers need to reinforce the ethics lessons students learn in school in the workplace. This can be done through employer-sponsored ethics workshops and by making it clear that CPAs are free to raise questions when they suspect possible wrongdoing.

"Continuing Dangers of Disinformation in Corporate Accounting Reports," by Edward J. Kane, NBER Working Paper No. W9634 --- http://papers.ssrn.com/sol3/papers.cfm?abstract_id=396694# 
 --- 

 

Abstract: Insiders can artificially deflect the market prices of financial instruments from their full-information or 'inside value' by issuing deceptive accounting reports. Incentive support for disinformational activity comes through forms of compensation that allow corporate insiders to profit extravagantly from temporary boosts in a firm's accounting condition or performance. In principle, outside auditing firms and other watchdog institutions help outside investors to identify and ignore disinformation. In practice, accountants can and do earn substantial profits from credentialling loophole-ridden measurement principles that conceal adverse developments from outside stakeholders. Although the Sarbanes-Oxley Act now requires top corporate officials to affirm the essential economic accuracy of any data their firms publish, officials of outside auditing firms are not obliged to express reservations they may have about the fundamental accuracy of the reports they audit. This asymmetry in obligations permits auditing firms to continue to be compensated for knowingly and willfully certifying valuation and itemization rules that generate misleading reports without fully exposing themselves to penalties their clients face for hiding adverse information. It is ironic that what are called accounting 'ethics' fail to embrace the profession's common-law duty of assuring the economic meaningfulness of the statements that clients pay it to endorse.

From The Wall Street Journal Accounting Educators' Review on April 16, 2004

TITLE: Damage Control: Auditors Hope for Liability Victory in U.K.
REPORTER: David Reilly
DATE: Apr 13, 2004
PAGE: C1
LINK: http://online.wsj.com/article/0,,SB108180626879680653,00.html 
TOPICS: Accounting, Auditing, International Auditing, Legal Liability

SUMMARY: The British Department of Trade and Industry is considering a change that would limit auditor liability in the United Kingdom. If auditor liability is limited in the United Kingdom, other European countries may follow. Questions focus on existing liability regimes and how changes are likely to impact the profession.

QUESTIONS:
1.) What is the standard of care required in the U.S. for audit services provided to public companies? Is this a realistic standard? Support your answer.

2.) What is limited liability? How does limited liability related to joint-and-several liability and separate-and-proportionate liability?

3.) Discuss the advantages and disadvantages of limited liability for the audit profession. Is it conceivable that limited liability would reduce the value of an audit? Support your answer.

4.) What are "deep pockets" ? How does the perception that auditors have deep pockets impact potential audit related litigation? Would limited liability change the "deep pockets" perception? Support your answer.

5.) What defenses are available to the auditor for litigation related to the audit of public companies? Even if the auditor is not found liable by the courts, does audit related litigation negatively impact the audit firm and the audit profession? Support your answer.

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

"Vendors hawk Sarbanes-Oxley wares," by Ann Bednars, NetworkWorldFusion --- http://www.nwfusion.com/news/2003/1110sox.html 

Like tax accountants in April, software vendors are lining up to help companies comply with regulatory issues set forth in the Sarbanes-Oxley Act of 2002. IBM, Oracle  and SAP are among the latest to unveil new and upgraded products designed to make it easier for companies to put in place internal processes and systems that will help them meet the requirements of the law.

Other vendors are listed in this article.

Whistle-Blower Woes
"Many companies think the whistle-blower provisions of Sarbanes-Oxley will spark nuisance suits by disgruntled employees. The truth is far more complex," by Alix Nyberg, CFO Magazine, October 01, 2003 --- http://www.cfo.com/article/1,5309,10790||BS||181,00.html?f=insidecfo 

When Matthew Whitley was laid off from his job last March as a finance manager at The Coca-Cola Co., along with about 1,000 other employees, he didn't take it lying down. Two months later, Whitley approached his former employer seeking a whopping settlement—$44.4 million—on the grounds that he had been fired in retaliation for raising concerns about accounting fraud. When Coke balked, Whitley turned for relief to a new ally: the Sarbanes-Oxley Act of 2002. He filed for whistle-blower protection under the act's Section 806 provisions, and initiated federal and state lawsuits that charged seven Coke executives, including CFO Gary Fayard, with crimes ranging from racketeering to mail and wire fraud.

"This disgruntled former employee has made a number of allegations accompanied by an ultimatum: that the company pay him almost $45 million or he would go to the media," said Coke in a May statement announcing the claims. Since then, a Georgia state court judge has dismissed most of the charges, including those related to racketeering and breaches of fiduciary responsibility. While Coke may still have to defend itself against claims related to wrongful termination, "we are confident we will prevail once the facts are presented in a court of law," said Coke in a statement.

One of Whitley's allegations, however, has already had some effect. His contention that Coke falsified a marketing test of Frozen Coke at Burger King restaurants in Virginia led the company to make a public apology and an offer to pay Burger King $21 million. In July, the Department of Justice (DoJ) announced it was launching a criminal investigation of the alleged fraud.

CFOs may be forgiven for fearing that cases like Whitley's are a harbinger of things to come—that, thanks to the protections afforded by Sarbanes-Oxley, irate workers will accuse their employers of financial wrongdoing in order to wring large settlements from them. Indeed, on August 27, a federal judge refused to dismiss a whistle-blower lawsuit accusing TXU Corp., an energy company, of earnings manipulation; unless the case is settled, it will become the second suit filed under Section 806 to reach a federal court (the first involved JDS Uniphase Corp.).

But it remains to be seen whether Sarbanes-Oxley will have a significant impact on whistle-blower litigation. Although the number of such filings has increased, most will probably be dismissed as lacking merit. And even with the new protections of Section 806, would-be whistle-blowers still face a painful cost-benefit decision: whether a lawsuit with uncertain chances of success is worth the professional and personal sacrifices that will assuredly be required.

Continued in the article

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

TheEnron Failure and the State of Corporate Disclosure, by Robert E. Litan, The Brookings Institute, April 2002 --- http://www.brookings.edu/comm/policybriefs/pb97.htm 

The failure of the Houston-based Enron Corporation poses some of the toughest policy challenges of any financial collapse in recent memory. The current situation is not comparable to the savings and loan crisis or the banking disasters of the 1980s, which were nearly a decade in the making before Congress finally took action. By comparison, the disclosure problems that have surfaced in the Enron case have been apparent only in the past several years, especially the growing numbers of earnings restatements and the rising concern about "earnings management" expressed by the Securities and Exchange Commission (SEC) and others. More importantly, whereas in the savings and loan and banking cases there were clear policy options that Congress could implement (notably the system of prompt corrective action for enforcing capital standards), there are very few options in the current corporate crises, and there appears to be only a limited consensus on which ones ought to be adopted.

However, there are several steps lawmakers can take to ensure that the public is not left in the dark about a company's financial health. In addition to continuing its extensive fact-finding mission on what happened at Enron, Congress should revisit rules on standards-setting in the accounting industry, tighten up enforcement and monitoring of accounting practices of both firms and their auditors, and make sure that any future laws give broad guidance to the SEC to allow for future developments in a rapidly changing corporate environment.

 
POLICY BRIEF #97

Improving the disclosure system is a complex task with few clear answers. According to former Federal Reserve Board Chairman Paul Volcker, now chairman of the trustees of the International Accounting Standards Board, the growing complexities of business-reflected in a dizzying array of new financial instruments and corporate organizational structures-pose increasingly difficult challenges for any system of disclosure. The fact is that for many kinds of transactions, there are no single "right" answers, which helps explain why the Financial Accounting Standards Board (FASB) often takes so long to set new standards or refine earlier ones, and why International Accounting Standards are framed in a more generic fashion. The lack of specifics allows accountants greater discretion in deciding how to justify various transactions.

As it considers how to improve the setting and enforcement of disclosure standards, Congress should be mindful that markets and regulators have already engaged in extensive "self-correction" in the wake of the Enron affair. A number of companies (including General Electric, America's largest in terms of market capitalization) already have delivered more disclosure; corporate boards, and their audit committees in particular, are paying closer attention to accounting issues and the choice of auditors; accounting firms have tightened up on their audits; financial analysts and credit rating agencies, chastened by their past performance, have become more discriminating; and the SEC is apparently doing the best it can with limited resources to scrutinize corporate financial statements for possible problems.

What Should Congress Do?

So, is there any room left for Congress to act? One reason for it to do so is to ensure that market-driven improvements in disclosure remain in place after the furor over Enron dies down. Another reason for congressional action is that the Enron failure, coupled with several major accounting misadventures in earlier years, have exposed weaknesses in the disclosure system that call for correction.

But Congress should also tread carefully. Markets move fast, legislation does not. What gets adopted today will live for many tomorrows-until something new happens that motivates new legislation. For this reason, any legislation that Congress adopts should give broad guidance to the SEC, and in this way allow for significant flexibility for policy to adapt to constantly changing circumstances.

Accounting Standards

The immediate accounting problem exposed by Enron's failure was the weak consolidation rule prescribed for highly leveraged "special purpose entities" (SPEs), or partnerships that were formed to carry out various projects whose assets and liabilities were not shown in Enron's balance sheet. Enron failed in part because of losses arising out of the many SPEs that it had created.

The rule for some time has been that sponsors of an SPE need not consolidate it so long as outside investors contribute a majority of its capital and that investment constitutes at least 3 percent of the SPE's assets. Leaving aside the fact that Enron appears to have misled its auditor, Andersen, about the amount of outside investments in SPEs (thus wrongfully avoiding consolidation), it is now clear that the 3 percent test was much too weak. FASB has since rightly raised the threshold to 10 percent.

The more difficult, larger issue relates to FASB's standard-setting process itself. FASB is slow to set standards-although the incredibly quick revision to the SPE rule, announced in March, is a notable exception-and when it does, it is often subject to political interference. Changing the funding of FASB from its current practice of accepting voluntary contributions from accounting firms and companies to some sort of mandatory assessment system, as some have suggested, would solve neither of these problems, although it might diminish any perception that FASB must tailor its views to those of its funders.

FASB's slow standard-setting could be addressed more directly by having the SEC impose deadlines on rule changes, with the threat that the SEC would take action on its own by a certain date if FASB did not, an idea floated by former SEC Chief Accountant Lynn Turner. Of course, the option of SEC taking over the standards-setting function is not ideal, because it could interfere with the other functions the commissioners perform and could not guarantee better outcomes. But the simple threat of occasional SEC rulemaking could be a powerful incentive for FASB to remain vigilant and act faster.

The downside of more active SEC involvement, however, is that it could result in even greater political interference in FASB's activities than already exists. There is a respectable view that politics is inherent in any rulemaking process, including the setting of accounting standards, and thus it is something that the public should accept. At the same time, however, the main purpose of accounting standards-at least for publicly held companies-is to protect the interests of investors, not accountants and not the firms themselves. Accounting standards should help investors understand all relevant financial facts that will enable them to make projections about future cash flows. Where the standards are altered or not implemented out of concern for affected firms rather than investors, the outcome may not be socially desirable. In theory, putting more investor or public representatives on FASB could help rectify the imbalance. In practice, however, if Congress wants the rules to benefit narrow interests, then there is little that even a more balanced FASB can do.

Similarly, moving the standards-setting function to the SEC is not a panacea because Congress still oversees the SEC. The same would be true if FASB members were chosen directly by the Commission. As long as the SEC oversees FASB in some way and Congress oversees the SEC, it is virtually impossible to remove politics from accounting standards-setting.

In principle, the only option that would have a chance of at least making some difference is to move standard-setting to an international body like the International Accounting Standards Board and thus accept international accounting standards (IAS), which the United States thus far has refused to do, largely out of the belief that U.S. Generally Accepted Accounting Principles (GAAP) is superior to IAS. This is not the rationale for moving to international standards that is typically cited. Instead, the case for IAS rests largely on the view that a single set of accounting standards worldwide would eliminate discrepancies in accounting standards across countries, thereby facilitating cross-border movement of capital. In addition, removing sources of uncertainty generated by differences in national accounting conventions should reduce the cost of capital. In the wake of Enron, others also have argued that a system like the IAS that allows accountants more discretion is superior to the heavily rules-based system of U.S. GAAP, which seemingly invites circumvention.

But perhaps the most important potential advantage of replacing U.S. GAAP with IAS is that it would dilute the political power of narrow interests in this country to influence the outcome of the standard-setting process. Take, for example, the fight over expensing stock options, which FASB was about to implement several years ago before it was stopped by a powerful lobbying campaign from the U.S. high-tech community. If standards were set solely by the IASB, our high-tech firms would make their views felt, but they could well run into significant opposition from standard-setters from other countries. Unfortunately, it is for just this reason that moving toward IAS would almost certainly arouse strong opposition in this country.

A better approach would be "constrained competition" in standard-setting. Under this approach-which appears to be gathering greater support within the academic community-U.S. law would give firms listing their shares on our stock exchanges a choice between using U.S. GAAP or IAS. Once some of the key differences between the standards are substantially narrowed, there would be no need for firms that choose IAS to undergo the expense of reconciling the differences between the two standards. The remaining differences between the standards would continue to exist, but would be of lesser magnitude. Then the two standards would simply compete, but the discrepancies would not be so large as to produce widely divergent results for most companies. In that way, investors would get the benefits of both greater harmonization (but not complete identity) of the two standards and the benefits of competition.

Enforcement
However much accounting standards may be perfected, investors will not be protected if auditors do not properly enforce the standards. In light of the rising numbers of auditing problems in recent years, culminating with Andersen's widely publicized failures with respect to its audit of Enron, attention has been focused on verification of financial statements. Policymakers should concentrate on two basic approaches, which are not mutually inconsistent, but ideally should be reinforcing: improved monitoring or oversight of auditors and improved incentives for auditors to carry out their work properly.

Monitoring
The most frequently discussed reform of the existing enforcement system is the creation of an independent body reporting to the SEC that would set and enforce auditing standards. SEC Chairman Harvey Pitt has outlined, and the Bush administration has basically endorsed, a proposal for a new Public Regulatory Board (replacing the previous Public Oversight Board) that would have authority to set auditing standards and to investigate and punish wayward auditors, even while charges are pending. Most of the members of the PRB would be independent of the accounting industry, while the functions of the Board would be financed by assessments on accountants and the firms they audit. Critics have said the proposal does not go far enough.

A better option, for a number of reasons, is to lodge the investigation and enforcement functions within the SEC, while leaving the preparation and refinement of audit standards for the auditing profession to an organization like the PRB.

First, proponents of an independent body cannot credibly assert that the job of overseeing auditors is more complex than overseeing the stock exchanges, investigating fraud or insider trading, or carrying out the rest of the Commission's statutory agenda. If the reason for contracting out the supervision of auditors is that the SEC is short of staff and resources, as it clearly is, there is an easy answer to that problem: give it the necessary resources and finance it by an assessment on accounting firms, the firms they audit, and/or investors.

If the reason for creating an independent board is to shelter it from political interference, then that argument is not sufficiently compelling. The SEC has effectively contracted out the setting of accounting standards to the FASB, but that has not prevented affected interests from influencing what the FASB does. In fact, precisely because enforcement is an inherent government function that is carried out for other industries by federal agencies, Congress quite properly exercises its oversight responsibilities over those enforcement efforts. It would be no different if the SEC were to oversee the auditing profession directly.

The only potentially plausible argument for creating the PRB is that the enforcement of auditing standards requires an understanding of the intent behind the standards, and so the two functions should be lodged in the same organization. And since the thought of having the SEC write audit standards seems to many like a non-starter, better to have both jobs carried out by an entity like the PRB under the SEC's oversight. But this too, is faulty logic. Many regulatory agencies write complex rules that they then enforce, so SEC could do both. Or it could rely on an entity like the PRB, which it would oversee, to write a first draft

Continued in the article

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

Auditors looking into the fraud at HealthSouth have found it to be far more extensive than originally thought-as much as $4.6 billion in all. Initially, estimates put the fraud at $3.5 billion at the Birmingham, AL-based operator of rehabilitative clinics.  The auditing firm implicated in the HealthSouth scandal is Ernst & Young --- http://www.AccountingWEB.com/cgi-bin/item.cgi?id=98609 

"Behind Wave of Corporate Fraud: A Change in How Auditors Work:  'Risk Based' Model Narrowed Focus of Their Procedures, Leaving Room for Trouble,' " by Jonathan Weil, The Wall Street Journal, March 25, 2004, Page A1

The recent wave of corporate fraud is raising a harsh question about the auditors who review and bless companies' financial results: How could they have missed all the wrongdoing? One little-discussed answer: a big change in the way audits are performed.

Consider what happened when James Lamphron and his team of Ernst & Young LLP accountants sat down early last year to plan their audit of HealthSouth Corp.'s 2002 financial statements. When they asked executives of the Birmingham, Ala., hospital chain if they were aware of any significant instances of fraud, the executives replied no. In their planning papers, the auditors wrote that HealthSouth's system for generating financial data was reliable, the company's executives were ethical, and that HealthSouth's management had "designed an environment for success."

As a result, the auditors performed far fewer tests of the numbers on the company's books than they would have at an audit client where they perceived the risk of accounting fraud to be higher. That's standard practice under the "risk-based audit" approach now used widely throughout the accounting profession. Among the items the Ernst & Young auditors didn't examine at all: additions of less than $5,000 to individual assets on the company's ledger.

Those numbers are where HealthSouth executives hid a big part of a giant fraud. This blind spot in the firm's auditing procedures is a key reason why former HealthSouth executives, 15 of whom have pleaded guilty to fraud charges, were able to overstate profits by $3 billion without anyone from Ernst & Young noticing until March 2003, when federal agents began making arrests.

A look at the risk-based approach also helps explain why investors continue to be socked by accounting scandals, from WorldCom Inc. and Tyco International Ltd. to Parmalat SpA, the Italian dairy company that admitted faking $4.8 billion in cash. Just because an accounting firm says it has audited a company's numbers doesn't mean it actually has checked them.

In a September 2003 speech, Daniel Goelzer, a member of the auditing profession's new regulator, the Public Company Accounting Oversight Board, called the risk-based approach one of the key factors "that seem to have contributed to the erosion of trust in auditing." Faced with difficulty in raising audit fees, Mr. Goelzer said, the major accounting firms during the 1990s began to stress cost controls. And they began to place greater emphasis on planning the scope of their work based on auditors' judgments about which clients are risky and which areas of a company's financial reports are most prone to error or fraud.

Auditors still plow through "high risk" items, such as derivative financial instruments or "related party" business dealings between a company and its executives. But ostensibly "low risk" items -- such as cash on the balance sheet or accounts that fluctuate little from year to year -- often get no more than a cursory review, for years at a stretch. Instead, auditors rely more heavily on what management tells them and the auditors' assessments of a company's "internal controls."

Old and New

A 2001 brochure by KPMG LLP, which claims to have pioneered the risk-based audit during the early 1990s, explained the difference between the old and new ways. Under a traditional "bottom up" audit, "the auditor gains assurance by examining all of the component parts of the financial statements, ensuring that the transactions recorded are complete and accurate." By comparison, under the "top down" risk-based audit methodology, auditors focus "less on the details of individual transactions" and use their knowledge of a company's business and organization "to identify risks that could affect the financial statements and to target audit effort in those areas."

So, for instance, if controls over a company's sales and customer IOUs are perceived to be strong, the auditor might mail out only a limited number of confirmation requests to companies that do business with the audit client at the end of the year. Instead, the auditor would rely more on the numbers spit out by the company's computers.

For inventory, the lower the perceived risk of errors or fraud, the less frequently junior-level accountants might be dispatched on surprise visits to a client's warehouses to oversee the company's procedures for counting unsold goods. If cash and securities on the balance sheet are deemed low risk, the auditor might mail out only a relative handful of confirmation requests to a company's banks or brokerage firms.

In theory, the risk-based approach should work fine, if an auditor is good at identifying the areas where misstatements are most likely to occur. Proponents advocate the shift as a cost-efficient improvement. They also say it forces auditors to pay needed attention to areas that are more subjective or complex.

"The problem is that there's not a lot of evidence that auditors are very good at assessing risk," says Charles Cullinan, an accounting professor at Bryant College in Smithfield, R.I., and co-author of a 2002 study that criticized the re-engineered audit process as ineffective at detecting fraud. "If you assess risk as low, and it really isn't low, you really could be missing the critical issues in the audit."

Auditors can't check all of a company's numbers, since that would make audits too expensive, particularly in an age of sprawling multinationals. The tools at auditors' disposal can't ensure the reliability of a company's numbers with absolute certainty. And in many ways, they haven't changed much over the modern industry's 160-year history.

Auditors scan the accounting records for inconsistencies. They ask people questions. That can mean independently contacting a client's customers to make sure they haven't struck undocumented side deals -- such as agreeing to buy more products today in exchange for a salesperson's oral promises of future discounts. They search for unrecorded liabilities by tracing cash disbursements to make sure the obligations are recorded properly. They examine invoices and the terms of sales contracts to check if a company is recording revenue prematurely.

Auditors are supposed to avoid becoming predictable. Otherwise, a client's management might figure out how to sneak things by them. It's also important to sample-test tiny accounting entries, even as low as a couple of hundred dollars. An old accounting trick is to fudge lots of tiny entries that appear insignificant individually but materially distort a company's financial statements when taken together.

Facing a crush of shareholder lawsuits over the accounting scandals of the past four years, the Big Four accounting firms say they are pouring tens of millions of dollars into improving their auditing techniques. KPMG's investigative division has doubled to 280 its force of forensic specialists, some hailing from the Federal Bureau of Investigation. PricewaterhouseCoopers LLP auditors attend seminars run by former Central Intelligence Agency operatives on how to spot deceitful managers by scrutinizing body language and verbal cues. Role-playing exercises teach how to stand up to a company's management.

But the firms aren't backing away from the concept of the risk-based audit itself. "It would really be negligent" not to take a risk-based approach, says Greg Weaver, head of Deloitte & Touche LLP's U.S. audit practice. Auditors need to "understand the areas that are likely to be more subject to error," he says. "Some might believe that if you cover those high-risk areas, you could do less work in other areas." But, he adds, "I don't think that's been a problem at Deloitte."

Mr. Lamphron, the Ernst & Young partner, and his firm blame HealthSouth's former executives for deceiving them. Mr. Lamphron declined to comment for this article. Testifying before a congressional subcommittee in November, he said he had looked through his audit papers and "tried to find that one string that, had we yanked it, would have unraveled this fraud. I know we planned and conducted a solid audit. We asked the right questions. We sought out the right documentation. Had we asked for additional documentation here or asked another question there, I think that it would have generated another false document and another lie."

The pioneers of the auditing industry had a more can-do spirit. In Britain during the 1840s, William Deloitte, whose firm continues today as Deloitte & Touche, made a name for himself by helping to unravel frauds at the Great Eastern Steamship Co. and Great Northern Railway. A growing breed of professionals such as William Cooper, whose name lives on in PricewaterhouseCoopers, began advertising their services as an essential means for rooting out fraud.

"The auditor who is able to detect fraud is -- other things being equal -- a better man than the auditor who cannot," wrote influential British accountant Lawrence Dicksee in his 1892 book, "Auditing," one of the earliest on the subject.

But in the U.S., the notion of the auditor as detective never quite took off. The Securities and Exchange Commission in the 1930s made audits mandatory for public companies. The auditing profession faced its first real public test in 1937, when an accounting scandal broke open at McKesson & Robbins: More than 20% of the assets reported by the drug company were fictitious inventory and customer IOUs. The auditors had been fooled by forged documents.

The case triggered some reforms. Auditing standards began requiring that auditors perform more substantive tests, such as contacting third parties to confirm customer IOUs and physically inspecting clients' warehouses to check inventories. However, the American Institute of Certified Public Accountants, the group that set auditing standards, repeatedly emphasized the limitations on auditors' ability to detect fraud, fearing liability exposure for its members.

By the 1970s, a new force emerged to erode audit quality: price competition. For decades, the AICPA had barred auditors from publicly advertising their services, making uninvited solicitations to rival firms' clients or participating in competitive-bidding contests. The institute was forced to lift those bans, however, when the federal government deemed them anticompetitive and threatened to bring antitrust lawsuits.

Bidding wars ensued. The pressures to hold down hours on a job "inadvertently discouraged auditors to look for" fraud, says Toby Bishop, president of the Association of Certified Fraud Examiners, a professional association.

Increasingly, audits became a commodity product. Flat-fee pricing became common. The big accounting firms spent much of the 1980s and 1990s building more-lucrative consulting operations. Many audit clients soon were paying their independent accounting firms far more money for consulting than auditing. The audit had become a mere foot in the door for the consultants. Economic pressures also brought a wave of mergers, winnowing down the number of accounting firms just as the number of publicly traded companies was exploding and corporate financial statements were becoming more complex.

Even before the recent rash of accounting scandals, the shift away from extensive line-by-line number crunching was drawing criticism. In an October 1999 speech, Lynn Turner, then the SEC's chief accountant, noted that more than 80% of the agency's accounting-fraud cases from 1987 to 1997 involved top executives. While the risk-based approach was focusing on information systems and the employees who fed them, auditors really needed to expand their scrutiny to include top executives, who with a few keystrokes could override their companies' systems.

Looking back, the risk-based approach's flaws are on display at a variety of accounting scandals, from WorldCom to Tyco to HealthSouth.

When WorldCom was a small, start-up telecommunications company, its outside auditor, Arthur Andersen LLP, did things the old-fashioned way. It tested the thousands of details of individual transactions, and it reviewed and confirmed the items in WorldCom's general ledger, where the company's accounting entries were first logged.

But as WorldCom grew, Andersen shifted toward what it called a risk-based "business audit process." By 1998, it was incurring more costs to audit WorldCom than it was billing, making up the difference with fees for consulting and other work, according to an investigative report last year by WorldCom's audit committee. In its 2000 audit proposal to WorldCom, Andersen said it considered itself "a committed member of [WorldCom's] team" and saw the company as a "flagship client and a crown jewel" of the firm.

Under the revised audit approach, Andersen used sophisticated software to analyze WorldCom's financial statements. The auditors gathered for brainstorming sessions, imagining ways WorldCom might cook its books. After identifying areas of high risk, the auditors checked the adequacy of internal controls in those areas by reviewing the company's procedures, discussing them with some employees and performing sample tests to see if the procedures were followed.

'Maximum Risk'

When questions arose, the auditors relied on the answers supplied by management, even though their software had rated WorldCom a "maximum risk" client, according to a January report by WorldCom's bankruptcy examiner, former U.S. Attorney General Richard Thornburgh.

One question that Andersen auditors routinely asked WorldCom management was whether they had made any "top side" adjustments -- meaning unusual accounting entries in a company's general ledger that are recorded after the books for a given quarter had closed. Each year, from 1999 through 2002, WorldCom management told the auditors they hadn't. According to Mr. Thornburgh's report, the auditors conducted no testing to corroborate if that was true.

They did check to see if there were any major swings in the items on the company's consolidated balance sheet. There weren't any, and from this, the auditors concluded that follow-up procedures weren't necessary. Indeed, WorldCom executives had manipulated its numbers so there wouldn't be any unusual variances.

Had the auditors dug into specific journal entries -- the debits and credits that are the initial entries of transactions or events into a company's accounting systems -- they would have seen hundreds of huge entries of suspiciously round numbers that had no supporting documentation.

The sole documentation for one $239 million journal entry, recorded after the close of the 1999 fourth quarter, was a sticky note bearing the number "$239,000,000," according to the WorldCom audit committee's report. Sometimes the "top side" adjustments boosted earnings by reversing liabilities. Other times they reclassified ordinary expenses as assets, which delayed recognition of costs. Other unsupported journal entries included one for precisely $334 million in July 2000, three weeks after the second quarter's books were closed. Another was for exactly $560 million in July 2001.

Andersen signed its last audit report for WorldCom in March 2002, saying the numbers were clean. Three months later, WorldCom announced that top executives, including its former chief financial officer, had improperly classified billions of dollars of ordinary expenses as assets. The final tally of fraudulent profits hit $10.6 billion. WorldCom filed for Chapter 11 reorganization in June 2002, marking the largest bankruptcy in U.S. history. Now out of business, Andersen is appealing its June 2002 felony conviction for obstruction of justice in connection with its botched audits of Enron Corp.

"No matter what kind of audit you do, it is virtually impossible for an auditor to detect purposeful fraud by management," says Patrick Dorton, an Andersen spokesman. "And that's exactly what happened at WorldCom."

PricewaterhouseCoopers also fell prone to faulty risk assessments. In July, the SEC forced Tyco, the industrial conglomerate, to restate its profits, which it inflated by $1.15 billion, pretax, from 1998 to 2001. The next month, the SEC barred the lead partner on the firm's Tyco audits from auditing publicly registered companies. His alleged offense: fraudulently representing to investors that his firm had conducted a proper audit. The SEC in its complaint said that the auditor, Richard Scalzo, who settled without admitting or denying the allegations, saw warning signs about top Tyco executives' integrity but never expanded his team's audit procedures.

Mr. Scalzo declined to comment. A PricewaterhouseCoopers spokesman declined to comment on the SEC's findings in the Tyco matter.

Like Tyco and WorldCom, HealthSouth grew mainly by buying other companies, using its own shares as currency. So it needed to keep its stock price up. To do that, the company admitted last year, it faked its profits.

In their audit-planning papers, Ernst & Young auditors noted HealthSouth executives' "excessive interest" in maintaining or increasing its stock price and earnings. Twice since the 1990s, the Justice Department had filed Medicare-fraud suits against HealthSouth.

But none of that shook the Ernst & Young audit team's confidence in management's integrity, members of the team later testified. And at little more than $1 million annually, Ernst & Young's audits were fairly low cost. The firm charged slightly less to audit HealthSouth's financial statements than it did for one of its other services for HealthSouth: performing janitorial inspections of the company's 1,800 health-care facilities. The inspections, performed by junior-level accountants armed with 50-point checklists, included checking to see that the toilets and ceilings were free of stains, the magazine racks were neat and orderly, and the trash receptacles all had liners.

Most of HealthSouth's fraud occurred in an account called "contractual adjustments." This is an allowance on the income statement that estimates the difference between the gross amount charged to a patient and the amount that various insurers, including Medicare, will pay for a specific treatment. The company manipulated the account to make net revenue and bottom-line earnings look higher. But for every dollar of illicit revenue, HealthSouth executives had to make a corresponding entry on the balance sheet, where the company listed its assets and liabilities.

An Ernst & Young spokesman, Charlie Perkins, says the firm "performed appropriate procedures" on the contractual-adjustment account.

At an April 2003 court hearing, Ernst & Young auditor William Curtis Miller testified that his team mainly had performed "analytical type procedures" on the contractual adjustments. These consisted of mathematical calculations to see if the account had fluctuated sharply overall, which it hadn't. As for the balance-sheet entries, prosecutors say HealthSouth executives knew the auditors didn't look at increases of less than $5,000, a point Ernst & Young acknowledges. So the executives broke up the entries into tiny pieces, sprinkling them across lots of assets.

The company's ledger showed thousands of unusual journal entries that reclassified everyday expenses -- such as gasoline and auto-service bills -- as assets. Had the auditors seen those items, one congresswoman noted at a November hearing, they would have spotted that something was wrong. Mr. Lamphron conceded her point.

Bob Jensen's threads on current scandals in the large auditing firms can be found at http://www.trinity.edu/rjensen/fraud.htm#others 

March 27, 2004 reply from MacEwan Wright, Victoria University [Mac.Wright@VU.EDU.AU] 

-----Original Message----- 
From:  
Sent: Saturday, March 27, 2004 10:29 PM 
Subject: Re: Attacks on Risk-Based Auditing

Dear Bob, 

I wonder if this is not a case of throwing the baby out with the bathwater. I mean the idea of risk based auditing is not in itself a bad idea, The problem is that the idea of what constitutes risk is not properly understood. As I interpret it - risk means probability of event multiplied by cost of event. Risk as used in audit planning means probability of event. It is obvious that the team did not do enough to properly evaluate the inherent risk or more properly stated - the probability that management would lie and cheat for profit.

It is am American attitude problem. An American executive posted to an Australian company found the amount of work put into finding out how honest potential employees were a waste of time - "just bond them and sack them and claim the bond insurance if they cheat". Bonding is virtually unheard of in Australia.

I feel that attitude may encourage fraud - the game is what can each party get away with!

Sorry about the social implications. 

Kind regards, 

Mac Wright

March 27, 2004 reply from Bob Jensen

Hi Mac,

You are correct about the fact that risk-based auditing has led to game playing. Somehow the HealthSouth executives figured out that the risk of getting caught with fraudulent transactions under $6,000 each was nearly zero under their auditor's (E&Y) risk-based model, so they looted the company with transactions under $6,000 each.

I agree with you that some form of risk-based auditing should be utilized.  I think this was the case long before KPMG formalized the concept.  However, in addition the fear of detailed testing of small transactions must still remain high among client employees. Auditors must invest more in unpredictable detailed testing up to a point where the probability of being audited for even small transactions is significant.

Probably the worst-case scenario that virtually eliminated fear of getting caught was Andersen's notoriously defective audits of Worldcom. I'm told (rumor mill) that an Andersen auditor had not even been seen in Worldcom's purchasing department for a number of years. What is the first department an auditor should investigate for fraud?

Bob

March 28, 2004 reply from Glen L Gray [vcact00f@CSUN.EDU]

I know a treasurer of a major company. It used to bug him that the auditors came by every year and take up her staff's time collecting & reconciling bank and investment information. Then a few years ago, they just stopped showing up in the treasury dept. I've always wondered what the auditor's risk model was if suddenly cash and investments were no longer important.

E&Y Faculty Connection --- http://www.ey.com/GLOBAL/content.nsf/US/EY_Faculty_Connection_(Issue_5) 

Ernst & Young Launches Audit Committee Outreach Efforts

Ernst & Young continues to undertake initiatives aimed at helping to restore investor confidence in the capital markets. In addition to implementing a number of professional development initiatives and quality and compliance safeguards within our own organization, we are also engaging in an ongoing dialogue with audit committees.

In 2003, Ernst & Young and Tapestry Networks founded the Audit Committee Leadership Network, a group of audit committee chairs who share insights and best practices on issues in the new audit environment. The ACLN includes directors from Aetna, American Express Company, Caterpillar Inc., The Coca-Cola Company, FedEx Corporation, The Home Depot, Inc., Newell Rubbermaid Inc., Pfizer Inc, Texas Instruments, and Viacom Inc. The Network, which first met in September, meets quarterly.

Some of the topics the ALCN has discussed so far include enterprise risk management, the role of the audit committee before and after a transaction, audit committee charters, audit committee priorities and performance, and the emerging roles and responsibilities of audit committees in light of changing regulations, expectations and relationships.

E&Y has also launched an information series on issues for audit committees and others concerned about financial reporting. The initiative includes BoardMatters Quarterly, an electronic newsletter, and a series of web-based forums for live discussions on emerging issues.

The first issue of BoardMatters Quarterly was released in late December and is available to EY Faculty Connection readers. This edition covers Section 404 of Sarbanes-Oxley and its implications, managing whistleblower processes, the composition of audit committees, and executive compensation. Upcoming issues will cover enterprise risk management, the changing role of internal audit, and other topics.

As an EY Faculty Connection reader, you will receive invitations to the web-based forums Ernst & Young will host on emerging issues for audit committees. The first of this series of "webcasts" will be held on the implications of Sarbanes-Oxley implementation for audit committee members. We will send notice of the webcast when the date has been finalized. Other webcasts that have been archived or are soon to be aired are listed in this newsletter, under Thought Center Webcasts.

At Ernst & Young, we are committed to restoring investor confidence. We welcome our faculty colleagues to join in the dialogue with audit committees on our webcasts as we collectively seek to address this critical issue.

E&Y Publishes Emerging Trends in Internal Controls

One of the most involved processes companies face today is implementing Section 404 of the Sarbanes-Oxley Act of 2002. Ernst & Young is engaged in an ongoing process of surveying major businesses representing virtually all industries in today's marketplace about their Section 404 preparations and processes. We are pleased to share our findings with EY Faculty Connection readers.

Emerging Trends in Internal Controls identifies what appear to be trends and practices among companies as they try to build effectiveness and efficiencies in their processes and embed control consciousness throughout their companies. We invited Dr. Larry Rittenberg, Professor of Accounting at the University of Wisconsin – Madison, to provide his insights on the educational and research implications of these emerging trends. Please see Dr. Rittenberg's comments in the From the Academy section

In an informal survey last spring, the Association to Advance Collegiate Schools of Business, which accredits business school programs, found that 35 percent of its member schools required students to take an ethics course. That was virtually unchanged from the results of a more formal study in 1988, in which a third of the association's members required ethics courses.

"A Question of Ethics: How to Teach Them?" by Christopher S. Stewart, The New York Times, March 21, 2004 --- http://www.nytimes.com/2004/03/21/business/yourmoney/21exli.html 

S scandals ripple through the corporate world, some business schools have introduced ethics courses, tweaked existing ones and conducted classroom conversations about the implosions of major companies like Enron and WorldCom.

Yet many business school professors, deans and students say that change is happening gradually.

"It's been slow going," said Fred J. Evans, dean of the College of Business and Economics at California State University at Northridge. In his opinion, he said, many business school professors are not yet well prepared to teach the subject.

"Schools bear some of the responsibility for the behavior of executives," he said. "If they're making systematic errors in the world, you have to go back to the schools and ask, 'What are you teaching?' "

In an informal survey last spring, the Association to Advance Collegiate Schools of Business, which accredits business school programs, found that 35 percent of its member schools required students to take an ethics course. That was virtually unchanged from the results of a more formal study in 1988, in which a third of the association's members required ethics courses.

Some elite schools, like Harvard, have started requiring ethics courses this year. "We've been looking into this for a few years, but it took some time to build," said Lynn S. Paine, a professor of business administration and a leader in designing the new course.

But other business schools have made no changes to their ethics curriculums. Many said their coverage of ethics was more than enough before the scandals broke. "We don't have an ethics requirement," said Sharon P. Smith, the dean of Fordham University's Graduate School of Business. "But we always talked about the subject in classes. It's a no-brainer for us. We don't shy away from questions of right and wrong."

Even when an ethics course is required, many students say the material is general or detached from the rest of the graduate curriculum.

"You have five profit-oriented classes during the semester where you're learning about free markets and shareholder maximization, and then there's one mandatory ethics course," said Chris Andrews, 30, who is in his second year at the McDonough School of Business at Georgetown University. "It's an abrupt transition, a tough way to learn about ethics. And you wonder if it can really prepare you for the real world."

In a recent survey conducted by the Aspen Institute, a nonprofit research center, roughly half of the 1,700 graduate business students who were interviewed said they thought they would have to make a decision in the future that would test their values. Only 22 percent said their schools were doing "a lot" to prepare them to manage value conflicts. One in five respondents said they were not being prepared at all.

"Everyone comes out thinking they're an ethical person," said one recent graduate of the University of Chicago Graduate School of Business. "And then all of a sudden you're working and there's money at stake."

The former student, who graduated in 2003, said that when he started work at an investment firm the summer after he graduated, he learned that the generic ethics cases used in school and the ethical situations encountered in the real world could be quite different. The contrast became particularly vivid, he said, when he spent several months researching a company in preparation for a big buyout and stumbled upon a number of potential problems that made him question the merit of the deal.

Everything "is tied to making the deal happen at this point," he said. "You have to ask yourself, 'Should I tell everyone there are some red flags and chance freaking everyone out and losing the account, or do I overlook it?' " he added. "This isn't something I learned about in any of those case studies." He disclosed the problems to his firm, a decision he said was based more on his own moral code than anything else. His firm is still evaluating the company.

Dr. Amitai Etzioni, a sociology professor at George Washington University who taught ethics at Harvard Business School in the 1980's, said that while many business schools had begun offering ethics courses, "they ghettoize the class."

"And most of the time the message to students is, 'Find a good lawyer so you can justify what you're doing,' " he added. "It doesn't tell you there are some basic values, that certain things are wrong."

ARCHIE CARROLL, a management professor who teaches ethics at the Terry College of Business at the University of Georgia, says that adding ethics training does not appear to be a priority at many schools. "I don't see governing boards at schools or advisory boards putting pressure on deans to teach more business ethics," he said.

Not long after corporate scandals began unfolding in late 2001 and early 2002, a group of professors and business executives began lobbying the business school accrediting association to require M.B.A. students to take a course in ethics. Late last year, however, the association said it would instead make the topic more prominent in its catalog of standards.

The Wharton School of the University of Pennsylvania, which has required M.B.A. students to take an ethics course since 1975, will begin offering a Ph.D. program in business ethics next fall.

The Haas School of Business at the University of California at Berkeley recently started the Center for Responsible Business, which includes seven new ethics courses. The program will require first-year students to visit executives in jail.

The Joseph M. Katz Graduate School of Business at the University of Pittsburgh dropped its ethics requirement last year in favor of steeping every class with ethics. Professors are now required to take a course in ethics training.

"We decided that having a separate ethics class was a lot like telling students that they could be bad during the week, but just had to go to church on Sunday," said Frederick W. Winter, dean of the school. "By taking out the one course, I think we'll be making every other course richer in the subject."

SOX = Sarbox = Sarbanes-Oxley Law

"A World of Trouble:  Even with an extended deadline for Sarbox compliance, questions about offshoring have companies on edge," by Craig Schneider, CFO Magazine, Spring 2004 Special Edition, pp. 41-44 --- http://www.cfo.com/article/1,5309,12609||M|846,00.html 

Beware a false sense of security: Even though the SEC has pushed back the deadline for compliance with Section 404 of the Sarbanes-Oxley Act of 2002, a little-known and perhaps largely outdated auditing standard for outsourcers could hamstring companies that are rushing to send their business processes offshore.

The standard in question is Statement on Auditing Standards No. 70, "Reports on the Processing of Transactions by Service Organizations." Set up by the American Institute of Certified Public Accountants in 1993, SAS 70 spells out how an external auditor should assess the internal controls of an outsourcing service provider and issue an attestation report to outside parties or to a client.

Auditors and other critics of the standard say SAS 70 is in need of a major overhaul, especially considering the November deadline for Section 404 compliance facing many public companies (see "Just What Does Section 404 Entail?").

Finance would seem to have more at stake than other corporate functions in clarifying the situation, since transferring financial tasks overseas can put material transactions in the hands of outsourcers. That will give finance folks pause regardless of how many cost-cutting sermons they've sat through. Stan Lepeak, a vice president at research firm Meta Group Inc., believes that incompatibilities between SAS 70 and Sarbox will "dampen outsourcing, at least in the short run, until outsourcers can show that they have both the adequate controls in place [and] evidence to prove that."

Tom Eubanks, global leader for finance and accounting outsourcing with IBM Business Consulting Services, isn't so sure. "At first blush," he says, "one might think, 'Why would you outsource in a world where Sarbox is in place...and the magnifying glass is on the finance function?'" But Eubanks turns that around and says that "companies are looking at outsourcing as a valid way to address some [Sarbanes-Oxley] issues."

All in the Timing Under SAS 70, an outsourcing-service provider undergoes an annual audit, performed either by its own independent auditor or by the auditors of its outsourcing clients. There are two types of service-auditor reports. Type I includes the service auditor's opinion on the fairness of the presentation of the provider's description of its controls and how well they're designed to meet specified control objectives. Type II reports, generally preferred for their greater depth, include the same data as Type I as well as the auditor's opinion on the effectiveness of the controls during the period under review.

Even a Type II report, however, doesn't guarantee airtight compliance with Sarbox. For one thing, the timing of the audit–if it's performed by the service provider's auditor–might be out of sync with the client's reporting period. If the audit is performed in June and the client's fiscal year ends December 31, for instance, there's a six-month gap in the attestation of the outsourcer's internal controls. If the controls slip up during the second half of the year, the accuracy and reliability of the client's own year-end attestation could be compromised–and fair game for a Securities and Exchange Commission inquiry.

One response to the timing issue is to request that the service provider undergo SAS 70 audits on a quarterly basis or "fill in the gaps" with updates throughout the year. Smaller service providers might bridle at the added cost during contract negotiations–but after all, it's the client's attestation that's on the line.

Another concern centers on just how much of the service provider's audit will be revealed. A service provider is required to inform its clients only about any failures of SAS 70 tests; there's no requirement to spell out the exact substance or scope of the audit. Thus, for instance, a client's own external auditor would be unable to tell the client whether a test that unearthed two failures probed 40 processes, or only 4. That could lead to some poor assessments of service-provider controls. "We will be dealing completely in the dark as far as the population of that test," says Lynn Edelson, systems and process assurance leader for PricewaterhouseCoopers. "I think that was one of the biggest flaws in SAS 70 in light of Sarbanes-Oxley."

Continued in the article.

"Where Are All the Poison Pills?" by Robin Sidel, The Wall Street Journal, March 2, 2004 --- http://online.wsj.com/article/0,,SB107818176447743400,00.html?mod=home%5Fwhats%5Fnews%5Fus 

The poison pill, one of the most popular corporate-takeover defenses of the past two decades, is getting tougher to swallow.

Faced with opposition from activist shareholders and new pressures to clean up governance after corporate scandals, companies are dismantling what has been one of the best known of the antitakeover mechanisms. In the past month, Circuit City Stores Inc., Goodyear Tire & Rubber Co., FirstEnergy Corp., PG&E Corp., and Raytheon Co., among others, all took steps toward eliminating their pills.

So far this year, a dozen companies have taken steps to dismantle their pills, compared with 29 for all of 2003 and just 18 in 2002, according to TrueCourse Inc., which tracks corporate-takeover defenses. Although such actions typically are heaviest just ahead of the annual-meeting season in which shareholders air gripes, people who follow corporate-governance issues say the trend is likely to continue through the year.

Meanwhile, fewer companies are putting the measure in place: The rate of new poison-pill adoptions fell to a 10-year low in 2003, according to TrueCourse. About 99 companies adopted new plans in 2003, down 42% from the prior year.

While there may still be a net gain in pills this year, the figures show the sharp decline in the rate of increase. "In the current environment, there is an increasing desire by boards to be viewed as following good governance and not be entrenched," says Alan Miller, co-chairman of proxy-solicitation firm Innisfree M&A Inc. "This is the flavor of the day, and it's going to accelerate."

Continued in the article

Message from SmartPros on March 1, 2004 --- http://www.smartpros.com/x42663.xml

Feb. 27, 2004 (washingtonpost.com) — The public continues to put too much faith in the precision of auditors, who should make clear in financial statements that they are providing their best opinions based on information that sometimes may be hard to quantify, according to a report released [Wednesday] by a blue-ribbon panel.

The group of 57 well-known figures in the financial world, including stock analysts, investor advocates, investment bankers and former Securities and Exchange Commission leaders, also called for auditors to receive more protection from lawsuits as part of the report titled "The Future of the Accounting Profession."

"If you really are going to require auditors to make more judgments, then you've got to protect them from the whims of juries," said Roderick M. Hills, a former SEC chairman who co-directed the effort. "Nine jury members can't substitute their judgment for the auditor's."

The accounting industry has come under intense public scrutiny after financial scandals led to bankruptcies at Enron Corp. and WorldCom Inc. Venerable accounting firm Arthur Andersen LLP collapsed in 2002 after an obstruction of justice conviction related to its client Enron. That same year, federal lawmakers limited the kinds of additional work auditors could perform for clients and created an oversight board to review how they perform their jobs .

Auditors cannot be "as precise as investors have believed and would want them to be," according to the 23-page report sponsored by Columbia University, which stressed that auditors cannot examine everything that occurs within a company. Instead, auditors should make clear they rely on information, including estimates of value provided by management, that could be subject to change.

The report also urged that more non-financial measures of a company's health appear on balance sheets, such as occupancy rates for firms in the hotel industry. This kind of information may be more volatile and difficult to use for purposes of year-over-year comparisons, the report said, but they would better represent the uncertainty of some elements of the business .

What's more, the report said, the Public Company Accounting Oversight Board should take a "supervisory" approach to regulating the accounting industry rather than stressing enforcement and prosecution. The report's authors said accounting regulators should follow the approach of bank examiners, who they said seek to prevent blowups rather than crack down after abuses have come to light.

Nell Minow, an investor protection advocate and co-founder of The Corporate Library, said the report was valuable because of the diversity of the people who produced it. "It's great to have all these different groups talking to each other," Minow said.

The Institute of Management Accountants (IMA) launched its Sarbanes-Oxley Knowledge Network http://www.imaknowledge.org/sox

March 3, 2004 message from Davidson, Dee (Dawn) [dgd@MARSHALL.USC.EDU]

This article was in RiskCenter today as a reprint from CIO magazine.  http://www.riskcenter.com/story.php?id=8214

RiskCenter is a free membership newsletter, but if anyone wants the full text, I can send it. 

March 3: Sarbox Risk - A Funny Thing Happened on the Way to Compliance

Location: New York
Author: Ben Worthen
Date: Wednesday, March 3, 2004

Congress responds to public outrage by passing legislation. Hence, the Sarbanes-Oxley Act, forged in the flames of the WorldCom, Tyco and Enron scandals. The act was intended to protect investors from executive fraud by requiring stricter standards for—and more oversight of—corporate accounting. As written, it's far-reaching—covering everything from who can sit on a board of directors to penalties for mistreating corporate whistle-blowers. And complying with it is potentially very expensive and time-consuming. When President George Bush signed the act into law in July 2002, corporate executives held their breath, waiting to see how the Securities and Exchange Commission would interpret it. (The law itself isn't as important as how the SEC chooses to apply and enforce it.) When the SEC proposed a strict interpretation three months later, they gulped. But when the SEC issued its final rule on the most important section of the law last June, they exhaled.

What You Thought (And What We Reported) No Longer Applies

A year ago, everyone was afraid of Sarbanes-Oxley. It looked as if companies were going to have to spend millions automating everything from ledger balancing to revenue accounting. Compliance promised to become a new cottage industry for software vendors. Now, it appears none of that need happen. Somewhere between the time the law left the president's desk in July 2002 and the SEC 's issuance of its final rule in June 2003, Sarbanes-Oxley, or Sarbox, or Sox, as it is variously and colloquially known, lost some of its teeth.

Of course, it can still bite. Companies will be forced to document their processes and change some of them. And compliance will still carry a price tag. But thanks to the final rule, CIOs will not have to confront the challenges and expenses of automation.

"You have to have adequate controls—not automated controls," says Joseph W. Hearington Jr., corporate director for internal auditing at Universal, a $2.6 billion tobacco company. "We have a combination of automated and manual, and that works for us. Our challenge isn't to reinvent the wheel, but to make sure we can prove that what we have works."

This is very different from what everyone thought—and from what the vendors and the technology press have been (and in some cases still are) saying and reporting. As recently as this past fall, articles continued to tell CIOs that technology is necessary to achieve Sarbanes-Oxley compliance and that their IT departments were directly in the line of federal fire. Even CIO ran an article last May warning companies that they were underestimating the role that their IT systems would play in Sarbanes-Oxley compliance.

The section of the Sarbanes-Oxley Act responsible for this furor is 404, which requires that both CEOs and CFOs test and attest to the effectiveness of their companies' internal controls. While the October 2002 SEC proposed rule did not elaborate on how effective "effective" needed to be, it made it perfectly clear how seriously it took Section 404 by interpreting internal controls in the broadest way possible. The proposal targeted "the company's entire system of internal controls, rather than just its internal accounting controls."

Most experts applied the same thoroughness to the rest of the section, including that tricky word effective. The only way to guarantee that a control is 100 percent effective, said the prevailing wisdom, was to remove the possibility of human error. A conservative reading of the SEC 's proposal, says Irwin Kishner, chairman of the corporate law department at Herrick, Feinstein, a firm whose clients include Bridgestone/Firestone and Hollinger International, would have outlawed the manual processes that bridged the gaps between automated systems—for example, reconciling financial data from multiple systems in a spreadsheet. Automating each of these processes would have cost companies millions and kept CIOs busy for years.

The reaction from affected companies (which was just about every company) was understandably negative, and what followed was a serious outbreak of politics.

How Sarbanes-Oxley Was Defanged

The first shot came from the White House. Just days before the SEC 's Section 404 proposal was released in October 2002, administration officials leaked word that President Bush wanted to cut the SEC 's budget more than $200 million, from the $776 million authorized in the Sarbanes-Oxley Act to $568 million. "You see a lot of rhetoric about trying to clean something up," says Larry Noble, executive director of the Center for Responsive Politics, a nonpartisan political watchdog group. "But when the rubber hits the road, they don't want to see any changes." According to the Center, seven of the the top 10 contributors to President Bush's current reelection campaign are financial services companies, precisely the constituency that would be most immediately and negatively affected by rigorous enforcement. "Their first choice is to derail a bill," Noble says. "But when an industry realizes that isn't going to happen, they try to water down the regulation."

Meanwhile, the SEC , as is its practice whenever it proposes a new rule, was soliciting feedback from companies and concerned individuals, and the responses to Section 404 resembled hate mail. In a representative comment, Eli Lilly's chief auditor said that the proposed rule would substantially increase costs while doing nothing to improve shareholder value. At a conference last May, John Gibson, president and CEO of Halliburton Energy Services—a major subsidiary of Halliburton, an enterprise with close and widely publicized ties to the administration (Vice President Dick Cheney was Halliburton's former chairman and CEO)—called Sarbanes-Oxley "the most ridiculous thing I've seen."

The SEC got the message, making what one official called "significant changes" in its final rule. Most notably, the final rule does away with the aforementioned broad interpretation of internal controls and replaces it with "internal controls over financial reporting." While this change may seem minor, Kishner says that its impact is major. "Financial controls are just a subset of internal controls," he says. "It is a less aggressive interpretation [of the law]."

With this less aggressive interpretation, the punctilious reading that would have rendered manual processes illegal no longer applied. Both the proposed and the final versions of the SEC rule require companies to identify weak points in their internal control processes and take steps to mitigate the risks those weaknesses create. But rather than making it necessary for companies to fix control weaknesses through automation, the new rule neither requires nor regulates how companies do it, says Deborah Birnbach, who specializes in technology-related litigation at Testa, Hurwitz & Thibeault. The lawyers, analysts, auditors and corporate executives consulted for this article all agree that complying with the rule requiring that internal financial controls be effective can entail nothing more than having someone run around double-checking manual work. "You don't have to spend millions of dollars to make things foolproof," says Birnbach.

That means it's left up to the enterprise to decide whether it wants to make a significant investment in technology that will automate its manual processes (which are still found in most every company) or make a smaller investment in additional people to run around and do the double-checking. And because no one is sure how the SEC will enforce the current rule or whether future changes will make the Sarbanes-Oxley Act tighter or looser, many companies are choosing the latter route. If they're wrong, there still will be time to buy and implement automation technology. If they're right, a small cost in human resources now will allow them to make IT investments on their own time line, not the government's.

 (more in article)

dee davidson
Leventhal School of Accounting
Marshall School of Business
University of Southern California
213.740.5018
dgd@marshall.usc.edu

Forwarded on March 6, 2004 by Todd Boyle [tboyle@ROSEHILL.NET]

Date: Sat, 6 Mar 2004 15:22:48 GMT
Subject: Financial Cryptography
Update: G30 - Accounting not to blame? From: iang@iang.org

A G30 report, Enhancing Public Confidence in Financial Reporting (2003), commissioned after the last few years' spate of corporate failures has stated that it is Governance that has failed, not accounting.

It is true that governance was the core failure in these cases. But, accounting is sleeping at the wheel, and asking to be not woken up right now is hardly useful.

Accounting, according to the G30 team, has integrity. Which, they drill down to mean these five criteria (See the doc for their definitions.):

1. Consistency 2. Neutrality 3. Reliability 4. Relevance 5. Understandability

These things can be done better. Consistency and Neutrality is achieved by more and deeper automation - this is widely known.

Building on the former two, Reliability is then created by liberal dashes of crypto - sign and hash everything in site.

Once these three things are in place, Relevance and Understandability follows with public disclosure: not the sort that the accountants are thinking about - regulated, limited, formally filed reports - rather the new, open and dynamic engagement with the scrutinizing public. Detail that is *outside* the regulatory environment, records that are in excess of requirements, but contribute to making a fair and open picture of a corporation.

Not, as the accountants think, by reducing the amount and simplicity of information so that the public can understand it, but, the total reverse: More quantity and more quality, so the public can ascertain for themselves what is important.

Why don't accountants think in these terms? I'd stab at this: they can't move because of the momentum of current practice and regulations. Which explains why the new trends appear in unregulated sectors such as DGCs, or previously unlisted companies such as eBay which reveals detailed statistics of its auction business.

-- http://www.financialcryptography.com/mt/archives/000084.html

Echoes of the G30 report can be found by Google, http://www.google.com/search?q=g30+%22Enhancing+Public+Confidence%22

Audits getting more intense under spotlight of SAS 99 --- http://snipurl.com/sas99

As Statement of Auditing Standards 99, Consideration of Fraud in a Financial Statement Audit, goes into effect, audit firms are realizing that its stiff new requirements can help a firm do a better job -- or doom a firm to litigation.

In either case, SAS 99 is most likely going to raise the cost of audits for nonpublic companies, including not-for-profits.

The Auditing Standards Board made an ineffectual attempt to deal with fraud in SAS 82, which went into effect in 1997. It didn’t do much more than simply require auditors to make a reasonable effort to find fraud.

The new standard pushes SAS 82 a lot farther, requiring of auditors a more strenuous effort to look for, if not actually find, misrepresentation in financial statements. Auditors are now required to presume malfeasance in management, to brainstorm the methods by which a client might commit fraud, to vary the pattern of the audit with surprise visits and procedures, and to document every anti-fraud effort that has been suggested or made.

Grace B. Ghezzi, a CPA and certified fraud examiner with Grimaldi & Associates CPAs PLLC, of Syracuse, N.Y., has been performing audits for fraud for over 12 years and, lately, has been traveling the nation to lecture on the new demands of SAS 99. She has found more curiosity than resistance.

“Clients are recognizing that we are taking on more responsibilities and that our profession is finally addressing fraud,” Ghezzi said.

After the devastating corporate financial scandals of 2001, the ASB wrote the more demanding SAS 99. It gives auditors specific guidance and procedures for looking for fraud, and, thus, to some extent defines the reasonable effort that auditors must make. It requires that the hunt for fraud continue throughout the audit process.

SAS 99 stresses the importance of revenue recognition, which is the most common type of financial statement fraud. It identifies inventory as the asset that is more materially misappropriated, and it calls for special assessment of management estimates because they are so subject to bias.

Audit firms can be held liable for neglecting to take all the appropriate steps that are specified in the statement. Gary D. Zeune, CPA, a frequent lecturer on the dangers, detection and prevention of fraud, said that SAS 99 can be friend or foe, depending on how well the audit firm has met its requirements.

“SAS 99 holds auditors to a higher standard of care,” Zeune said. “If they don’t meet the reasonable assurance requirement, the standard gives a plaintiff’s lawyers a roadmap of how to sue an accounting firm.”

On the other hand, Zeune said, the standard tells auditors how to do the job right. SAS 99 says: “Stop making it easy for the client to pull the wool over your eyes,” Zeune explained. “If you look at the procedures that SAS 99 says you should do, that’s the message between the lines. Do the procedures on a surprise basis. Don’t do the same damn thing every time. Don’t automatically trust your client because you’ve never had a problem in 27 years. Every year’s audit has to stand on its own.”

Ghezzi said that communication is of crucial importance in the search for fraud, and SAS 99 requires, for the first time, that auditors talk to each other and to management. The audit team must discuss ways in which a client may be susceptible to fraud, and they must document their discussion. They must talk with management to assess internal controls, look for ways that controls can be overridden, and then test those risks. They must also talk to personnel, including people who have nothing to do with accounting, bookkeeping or finance.

She told the story of a visit to a client whose inventory had been disappearing. She asked to speak with a variety of workers, including a maintenance man. The managers said, “You don’t need to talk to that old guy. He don’t know nothin’.” She insisted, however, and asked the man if he knew anything about the thefts. He asked her if she’d like to see his photo album.

It turned out that he had pictures of the in-house thieves in the act of their evil deed. 

Why hadn’t he reported the thefts? Because management didn’t respect him. He told Ghezzi, “They think I don’t know nothin’.”

Ghezzi said that, in general, auditors know about SAS 99   and what is expected of them. Not all, however, have enough training in interviewing and identifying the warning signs of fraud. A big sale at the end of the year, for example, followed by high levels of returns early in the next year can indicate a manager who is desperately juggling figures to meet revenue expectations.

Toby J.F. Bishop, president and chief executive officer of the Association of Certified Fraud Examiners, said that SAS 99 does too little to detect fraud and barely begins to prevent it.

“I haven’t heard anyone say that this is a silver bullet that will finally allow them to detect all fraud,” Bishop said. “It is impossible for auditors to detect 100 percent of fraud at any degree of cost and practicality, so a strategy aimed at fraud detection alone is a losing strategy. Our profession needs to focus at least as much, if not more, on fraud prevention.”

Bishop said that SAS 99 gives only off-hand mention of auditing the internal controls that could prevent a lot of fraud. The standard does not provide procedures or require an opinion on the adequacy of internal controls.

Continued in the article

From The Wall Street Journal Accounting Educators' Review on February 13, 2004

TITLE: Companies Complain About Cost Of Corporate Governance Rules
REPORTER: Deborah Solomon and Cassell Bryan-Low
DATE: Feb 10, 2004
PAGE: A1
LINK: http://online.wsj.com/article/0,,SB107636732884524922,00.html
TOPICS: Accounting, Accounting Law, Assurance Services, Audit Quality, Auditing, Auditing Services, Internal Controls, Regulation, Sarbanes-Oxley Act

SUMMARY: Companies are beginning to implement internal control systems to
comply with the requirements of the Sarbanes-Oxley Act (SOX). A primary
purpose of the SOX was to improve investor confidence in financial reporting;
however, companies are reporting that the cost of compliance is excessive.

QUESTIONS:
1.) What is the purpose of a system of internal controls as it relates to
financial reporting? Prior to the Sarbanes-Oxley Act what was the auditor's
responsibilities for internal controls? Compare and contrast management's
needs for internal control and the auditor's responsibility for assessing
internal control?

2.) What is cost-benefit analysis? Does the Sarbanes-Oxley Act change the
importance of cost-benefit analysis in designing and implementing internal
controls? Briefly describe potential costs and benefits of internal control.

3.) Discuss the advantages and disadvantages of the additional internal control
requirements imposed by the Sarbanes-Oxley Act?

4.) Estimate the percentage of first-year internal control related costs as a
percentage of revenues. Does it appear that the Sarbanes-Oxley Act has more
impact on any particular size of company? Support your answer.

5.) Do the internal control requirements of the Sarbanes-Oxley Act impose an
unnecessary burden on public companies? Support your answer.

6.) Describe the difference between changes in income that are related to
additional control and reporting requirements and changes in income that are
related to changes in accounting for a specific economic event.

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

November 19, 2003 message from Colleen Sayther [mailmanager@feiexpress.fei.org] 

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

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

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

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

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

Question
Who is Edward Nusbaum?

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

Continued in the article at  http://www.fei.org/mag/articles/11-2002_FR.cfm 

The GAO issued a report on the effects of consolidation in the auditing profession, resulting in the Big Four firms which audit the majority of public companies. The GAO has issued a supplemental report, providing views of CEOs and CFOs on the consolidation of the industry. http://www.accountingweb.com/item/98020 

The GAO report can be downloaded from http://www.gao.gov/new.items/d031158.pdf 

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

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

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

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

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

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

August 3, 2003 excerpt from a speech by Art Wyatt (See the link below that Tracey provides)

The firms need to consider a number of initiatives.  The tone at the top of the firms needs to change.  As a starting point, leadership of the major firms might require that their managing partners meet the standards established by Sarbanes-Oxley for the individual on SEC-registrant audit committees that is designated as a qualified financial expert.  Recent managing partners have too often been chief cheerleaders promoting revenue growth or individuals with more administrative expertise than accounting and auditing expertise.  The policies established at the top of the firms must be approved by and articulated by individuals who have the professional respect of the managers and staff.  The challenge to restore the primacy of professional behavior in the conduct of services rendered will not be easily met.  Such restoration likely will not be met at all if the chief messenger is known throughout the firm as being primarily an advocate of revenue growth even when that growth may be at the expense of the firm's reputation for outstanding professionalism in the delivery of its services.

The top leadership in the firms also needs to consider whether the four largest firms are really effectively unmanageable.  In smaller accounting firms (or when the current four large firms were smaller), a key partner is able to monitor partner performance and be able to assess the strengths and weaknesses of the individual partners.  As the large firms have grown to their current size, the challenge to have such effective monitoring is substantial.  Maybe some consideration should be given to whether a split-up of a big firm would enhance the firm's quality control and permit more effective delivery of quality service.  While such a thought will no doubt be draconian to some, one only has to consider what might be the end result if one of the current four large firms meets the same fate as Andersen.  Firm break-ups might then be at the mercy of legislative or regulatory intervention--an even more draconian thought.  The bottom line, however, is, are the large firms able to manage their practices effectively to assure top quality service to their clients and the public?

The firms need to place greater internal emphasis on quality control in audit performance.  More effort should be devoted to assuring that clients have met the intent of the applicable accounting standards, and less effort should be devoted to assisting clients to structure transactions to avoid the intent (and sometimes the letter) of the standards.  In working with the FASB the focus of the firms should be on pressuring the FASB to develop standards that are conceptually sound and that avoid compromises that are designed to keep one segment of society happy at the expense of sound financial reporting.  Too often the accounting firms have acted at the direction of their clients in lobbying the FASB on specific technical issues and have not met the standards of professionalism that the public can rightfully expect from the leading accounting firms.  Too many of the FASB standards contain conceptual impurities that encourage gaming the system, and too many firms are active participants in the gaming activity.  Lobbying the FASB on behalf of particular client interests is not professional on its face and casts as much of a cloud on the firm's independence as does providing a range of consulting services to audit clients.

As a side note, I have seen comments by leaders of several of the Big 4 firms recently suggesting that the real cause of recent financial statement shortcomings is the failure of existing accounting standards to reflect the underlying economics of reporting companies.  These statements seem to be self-serving attempts to deflect criticism from accounting firm performance to the adequacy of the current set of generally accepted accounting principles.  To test the sincerity of these comments, I suggest one analyze the recent firm submission to the FASB on proposed standards that have emphasized economic reality over "backward-looking historical cost."  I suspect such analysis would suggest the several firms have missed numerous opportunities to encourage the FASB in its efforts to adopt standards that reflect better economic reality and, in fact, have often taken strongly contrary positions, at least in part at the urging of their clients.

While on the subject of the FASB, we need to recognize that the Board fared well in the Sarbanes-Oxley legislation.  Going forward, the Board needs to do a better job in educating congressmen and senators on their proposed standards and why the lobbying efforts of constituents are often far more self-serving than desirable from the perspective of fair financial reporting.  The Board needs to attack a significant number of its existing standards that are conceptually unsound and that embody a series of arbitrary boundaries that attempt to prevent users from misapplying the standard.  We should have learned by now that standards that contain arbitrary rules in the attempt to circumvent aberrant behavior really act to encourage that very behavior.  Firm leaders should recognize that their audit personnel will be far better off in dealing with aggressive client behavior if the standards that are operational are soundly based and consistent with the Board's conceptual framework.  Isn't it more important to provide your staff with the best possible tools to meet their challenges than it is to gain some short-term warm feelings by bowing to a client's wishes?  The big firms need to decide that the FASB is their ally, not their opponent, and become more statesmanlike in pursuing sound accounting standards.  This will require leaders who understand the nuances of technical accounting requirements and who are able to grasp that acceptable levels of profitability will flow from delivering top quality professional service to clients.

September 10, 2003 message from Tracey Sutherland [tracey@aaahq.org] 

The 88th Annual Meeting of the American Accounting Association was held August 3-6, 2003, in Honolulu, Hawaii. Opening speaker Arthur R. Wyatt's presentation garnered a standing ovation. So that his comments can be shared beyond those able to attend the meeting the full text of his challenging speech, "Accounting Professionalism--They Just Don't Get It!" is available online at http://aaahq.org/AM2003/WyattSpeech.pdf 

Auditing With SOX On!

"How Sarbanes-Oxley Will Change the Audit Process," by Donald K. McConnell, Jr. and George Y. Banks, Journal of Accountancy, September 2003, pp. 49-56 --- http://www.aicpa.org/pubs/jofa/sep2003/mcconn.htm 

SARBANES-OXLEY WILL MEAN BIG CHANGES FOR BOTH auditors and the companies they audit. The former now will be required to certify a company’s internal controls and will no longer be able to use certain common audit strategies. Management faces the cost of implementing the new rules. ACCORDING TO THE EXPOSURE DRAFT OF A NEW SAS, the understanding of internal controls required for CPAs to express an opinion on financial statements is not adequate for them to offer an opinion on the controls themselves. This means auditors will have to make changes to the audit process. THE AUDITOR MUST ATTEST TO MANAGEMENT’S assessment of the effectiveness of an entity’s internal controls using standards the Public Company Accounting Oversight Board issues or adopts. The auditor will require management to identify, document and evaluate significant internal controls—management cannot delegate this function to the auditor. AUDITORS SHOULD ADVISE COMPANIES TO BEGIN the process of assessing the effectiveness of controls as early as possible. The task will be time-consuming, requiring management to determine which locations or business units to include in its evaluation. AUDITORS SHOULD NOT BE TOO CLOSELY INVOLVED with a company’s assessment of its controls or they risk impairing their objectivity. The auditor cannot accept management’s responsibility to reach conclusions on the effectiveness of the entity’s controls nor can management base its assertion about the controls design and operating effectiveness on the results of the auditor’s tests.

DONALD K. McCONNELL JR., CPA, CFE, PhD, is associate professor of accounting at the University of Texas at Arlington. His e-mail address is donaldmcconnell@charter.net. GEORGE Y. BANKS, CPA, is a partner of Grant Thornton in Dallas. His e-mail address is gbanks@gt.com.

From Fortune, August 11, 2003 --- http://www.fortune.com/fortune/investing/articles/0,15114,474483,00.html 

A Taste of Success But the real test for Sarbanes-Oxley is still ahead. FORTUNE Monday, August 11, 2003 By Jeremy Kahn

The Securities and Exchange Commission held a small ceremony in late July to commemorate the one-year anniversary of the enactment of the Sarbanes-Oxley Corporate Responsibility Act. That same day SEC chairman William Donaldson gave a speech before the National Press Club in which he hailed Sarbanes-Oxley as the most significant piece of federal securities legislation since the securities laws were first enacted in the 1930s.

Sarbanes-Oxley has improved financial disclosure, forced executives and boards to be more vigilant, ended self-regulation of audit firms, and helped eliminate conflicts of interest in stock research. That said, it's too soon to call it a success.

"Who Does What to Whom?  Closing the Expectation Gap of Section 404, by Colleen A. Sayther (President of Financial Executives International), Financial Executive, September 2003, Page 6 --- http://www.fei.org/mag/articles/9-2003_president.cfm 

Issues surrounding the various facets of Sarbanes-Oxley continue to emerge, challenging us as financial executives. Perhaps one of the thorniest areas of debate is Section 404 on Management Assessment of Internal Controls, which requires corporate managers to evaluate and report on the effectiveness of internal controls over financial reporting, identifying any "material weaknesses" they find. Further, the act requires a public company's outside auditors to attest to management's assessment of those internal controls.

And at that point, interpretations diverge. There is an ongoing debate between issuers and public accounting firms over how deeply auditors should delve. Preparers contend - and FEI agrees - that auditors should attest only to management's assessment and evaluation of internal controls. Audit firms, on the other hand, believe that auditors must attest to the actual internal control environment itself. They believe that they cannot attest to management's assessment without doing substantial work to conclude that the actual internal control environment is effective.

On July 29, I participated in a roundtable discussion held by the Public Company Accounting Oversight Board (PCAOB) to solicit views on this divisive issue - from auditors, investors, public companies, regulators and other stakeholders. I can tell you that feelings run very high on both sides of the debate.

In weighing the merits of both interpretations, it is important to remember one essential point: The internal control environment is ultimately the responsibility of management. It should not be delegated to the auditors. To do so would represent an abrogation of fiscal responsibility on the part of management and an inappropriate assumption of that responsibility by the public accounting firms.

FEI believes that the clear intent of Sarbanes-Oxley regulation in this area was to ensure that management took the necessary and appropriate responsibility for not only creating an effective internal control system, but also reviewing it on an ongoing basis. Further, we believe that Sarbanes-Oxley recognizes that independent auditors have a responsibility to understand the internal controls so that they can plan their audit. By having the independent auditor attest to management's assertion, we believe the intent of Congress - to have the independent auditors fulfill this responsibility in a manner more transparent to investors - is satisfied.

The material failures in corporate governance procedures that have rocked the corporate world lately result not from breakdowns of basic transaction controls, but from subsequent manipulations by management of the information provided by these systems. Our view remains that, based on existing attestation standards, the cost for the independent auditor to render an opinion directly on the effectiveness of an issuer's internal control system far exceeds the potential benefits for the investing public.

We believe that the focus of the auditor's work should be restricted to a review and evaluation of management's assertion on the effectiveness of its internal controls and the related documentation - not retesting and revalidating the entire internal control environment. There is a significant difference in the degree of work involved in the two approaches. This translates, not surprisingly, into a significant difference in cost.

We recognize that the auditors need to test management's assessment in order to attest, and that this work is not free. What is important, however, is striking a balance between the cost to implement and the value received. As with other aspects of Sarbanes-Oxley implementation, FEI feels strongly that the best regulation is one that accomplishes its stated objectives without placing an undue burden on businesses.

Continued in the article.

"Worry Over a New Conflict for Accounting Firms," by Jonathan D. Glater, The New York Times, September 23, 2003 

Critics worry that auditors will advise companies on their controls and then end up approving their own work.

"Designing a Section 404 Project," by Tiffany McCann and Cheryl De Mesa Graziano, Financial Executive, September 2003, pp. 44-46 --- http://www.fei.org/mag/articles/9-2003_compliance.cfm 

Risk Areas As Section 404 implementations progress, financial managers are uncovering challenges. For example, processes and controls are not the only important pieces of information in internal control documentation. "Financial information that requires a high degree of judgment often comes from disparate sources within a company. The processes behind disparate sources, like models or assumptions, need to be identified, documented and tested. So a compliance tool needs to capture both the processes and the data flows producing financial statement amounts," says PwC's Everson.

The example he provides is the analysis for the allowance for doubtful accounts, a highly subjective number on the financial statements. A company may document its process as quarterly evaluation by the collections manager, but the information that really needs to be documented is what assumptions were used by the collections manager in the evaluation.

Another challenging area involves IT controls, a key area since so many of today's business processes are IT- driven. "One of our core team members has an IT background [to ensure IT issues are considered during implementation]," says Koen Van Loock, project leader for Section 404 at Lilly. "A general IT controls section is included in the documentation of each process and must be completed by a person with an IT background," he adds.

In the testing phase of Section 404 implementation, financial executives are finding little or no specific guidance on the extent of testing required for compliance. "Management will not get specific guidance for testing. It is management's responsibility to decide what is necessary to make the assertion that controls are operating effectively," says DeLoach. Protiviti encourages clients to consider a range of testing methods, from self-assessment to statistical sampling, depending on the nature of the risks and controls inherent to the process and the controls mitigating those risks.

Continued in the article.

Hundreds of small accounting firms are struggling under tough new auditing rules adopted after a string of corporate scandals and regulatory probes, and several are exiting parts of the business they view as increasingly risky, according to industry experts --- http://www.smartpros.com/x40299.xml 

The following was announced in the PCOAB Update newsletter for September 2003:

PCAOB Receives 349 Registrations As Deadline looms

The deadline for registration is October 22, 2003, and the Public Company Accounting Oversight Board's regulations allow the Board up to 45 days for review of applications.  This means that firms were required to submit their registration by no later than September 7, 2003.   Based upon a release posted on the Board's website, 349 firms submitted aplications for registration through September 8, 2003.  See http://www.pcaobus.org/RegistrantsList.pdf for the up to date list of registrants.     

September 9, 2003 reply from Todd Boyle [tboyle@ROSEHILL.NET] 

I urge all of you to re-examine the foundations and assumptions of the corporate system in this country.

Re-examine them objectively, with an eye to improvement. Visit these three websites:

1. http://www.citizenworks.org/  and sign up for the excellent, weekly Drutman letter. 
2. http://www.poclad.org  and engage with them. http://www.poclad.org/engage.html  
3. http://www.wilpf.org/corp/corp-personhood.htm  and read the PDFs. Revolutionary.

There are active ACP initiative campaigns in numerous States. I think these people are on the right track.

This is not light reading. The problem is not an easy problem. CPAs have a valuable contribution to make.

Todd Boyle, CPA 
http://www.ledgerism.net/FinancialDeregulation.htm 

In its top-to-bottom review of all aspects of the auditing business, the Public Company Accounting Oversight Board (PCAOB) has turned its attention to tax shelters. http://www.accountingweb.com/item/98106 

"Grant Thornton Ends Internal Controls Services for Audit Clients," SmartPros, September 4, 2003 --- http://www.smartpros.com/x40452.xml 

Grant Thornton, the fifth largest accounting firm, announced that it will not provide a number of internal control services for its public audit clients that it believes is in keeping with the intent of the Sarbanes-Oxley Act of 2002.

"Just as we believe that the accounting industry should accept a principles versus rules based approach to accounting, we believe the same should be the case in adhering to the Sarbanes-Oxley Act," said Grant Thornton CEO Ed Nusbaum. "There are areas in the legislation that are clear, and some that might be interpreted differently by others. But the guide in gray areas should be the spirit of reform and protection of investors that the bill's authors intended."

Nusbaum said Grant Thornton will not accept engagements to document its public audit clients' internal controls, but would instead refer the client to another firm.

Also, Grant Thornton said it will not provide other services, such as design controls, design or implement processes that impact the financial reporting processes, and access to software that is used by its auditors to document and evaluate controls over financial reporting.

Grant Thornton will attest to, and report on, management's assessment of internal controls of its public audit clients under Section 404 of the Sarbanes-Oxley Act, and will continue to provide a wide array of internal controls services for public companies that are not audit clients.

From The Wall Street Journal Accounting Educators' Reviews on September 5, 2003

TITLE: More Truth-in-Labeling for Accounting Carries Liabilities 
REPORTER: Michael Rapoport and Jonathan Weil 
DATE: Aug 28, 2003 
PAGE: C1
LINK: http://online.wsj.com/article/0,,SB106202746728648800,00.html  
TOPICS: Debt, Debt Covenants, Financial Accounting, Financial Accounting Standards Board

SUMMARY: FASB Statement No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity, requires classifying mandatorily redeemable preferred stock as debt, among other things. The article discusses implications for companies' debt-to-equity ratios, referring to specific companies' financial statements, and makes comparisons to convertible bonds.

QUESTIONS: 
1.) Define preferred stock and common stock. How are these items classified on the balance sheet? Define mandatorily redeemable preferred stock and trust preferred stock. Prior to the issuance of SFAS 150, how were each of these items classified? What classification will they now hold following the issuance of SFAS 150?

2.) Define convertible debt. How is this item accounted for and classified in companies' balance sheets? What is the problem with this accounting treatment that the "FASB next plans to tackle"?

3.) How will the change under SFAS 150 affect companies' debt-to-equity ratios? What will they do to alleviate potential problems? Can you think of any other ratios that could be affected by this change? Name them and explain.

4.) What are the concerns with Xerox's balance sheet that are expressed in the article? Access Xerox's financial statements on the company's web site at http://a1851.g.akamaitech.net/f/1851/2996/24h/cache.xerox.com/downloads/usa/en/ i/ir_annualreport2002.pdf and proceeding to page 41 (numbered page 39 in the report). What amount shows as total liabilities? How can you calculate total shareholders' equity? Will this amount change under the new accounting standard?

5.) Given your assessment of Xerox's balance sheet under question #4, above, are you concerned about the company's statement that its disclosure and accounting treatment 'is consistent with the specific guidance' issued by the Securities and Exchange Commission? In general, does this guidance differ from guidance issued by the FASB?

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

Forwarded on April 16, 2003 by MABDOLMOHAMM@BENTLEY.EDU 

U.S. accounting board votes to set auditing rules

April 16, 2003 11:14am ET (Reuters)

WASHINGTON, April 16 (Reuters) - The new U.S. board set up to regulate accountants on Wednesday voted to take over responsibility for setting auditing rules, marking the end of an era in which the accounting industry set its own standards.

Under the Sarbanes-Oxley Act -- a sweeping corporate reform bill passed last year -- the Public Company Accounting Oversight Board had the option to leave the auditing standard-setting process to another group, but decided against that.

So far, the accounting profession has been governed by auditing rules developed and issued by the Auditing Standards Board, an arm of the industry's main trade and lobby group -- the American Institute of Certified Public Accountants.

The recently formed accounting board, which named departing New York Federal Reserve President William McDonough as its new head on Tuesday, also agreed to set auditing rules with help from an advisory group to be set up comprising of accounting, investing and other experts.

Apart from setting auditing rules, the board's other crucial task will be to regularly inspect major accounting firms. It can also revoke an auditing firm's registration and set fines up to $15 million.

March 5, 2003 message from Dennis Beresford [dberesfo@terry.uga.edu] 

Bob,

I don't know whether you've heard of the Association for Integrity in Accounting. I've attached a document that describes its activities, one of which is to seek abolishment of the FASB. I'm sure these folks are well intentioned, but it would be nice if some of these academics devoted themselves to more positive pursuits.

Feel free to mention this in your Bookmarks if you think it would be worthwhile.

Denny

Note from Bob Jensen
The AIA home page is at http://www.citizenworks.org/actions/aia.php 

Press Statements

Ralph Nader, consumer advocate, founder, Citizen Works --- http://www.citizenworks.org/ 

Tony Tinker, professor of accountancy, CUNY-Baruch College --- http://www.baruch.cuny.edu/ 

Linda Ruchala, associate professor of accountancy, University of Nebraska-Lincoln --- http://www.unl.edu/unlpub/index.shtml 

The Association for Integrity in Accounting (AIA) is a project being incubated by Citizen Works, a nonprofit, nonpartisan, 501 (c) (3) tax-exempt organization founded by Ralph Nader in April 2001 to advance justice by strengthening citizen participation in power.  Contact Information: Citizen Works, PO Box 18478 , Washington , DC 20036 -- Phone: (202) 265-6164 -- Fax: (202) 265-0182 -- info@citizenworks.org 

AIA Mission Statement

Whereas the integrity of the accounting profession is premised on individuals who acknowledge their responsibility to maintain expertise, to exercise independence of thought and action, and to serve and be guardians of the public interest; and

Whereas the influence of corporate pressures on professional standards have eroded and compromised this integrity;

The mission of the Association for Integrity in Accounting is to provide an independent forum to present and advance positions on a wide range of critical accounting and auditing issues, standards and regulations affecting the accountability and integrity of the profession and the public interest in maintaining trust and confidence in accounting.

The Association for Integrity in Accounting includes members, domestic and international, from private, public, and academic accounting (as well as students and others) interested in the advancement of accounting to support a more informed public.

Steering Committee Members

1.      David Crowther - David spent over twenty years as a practicing accountant in the various sectors of the UK economy prior to becoming an academic. After entering the academic world he completed a Ph.D. in corporate social reporting. He is now Professor of Corporate Responsibility at London Metropolitan University .

2.      Jesse Dillard - Jesse Dillard is the KPMG Professor at the School of Accountancy , University of Central Florida , and editor of Accounting and the Public Interest. He has published in the accounting and business literature, and is currently studying the ethical implications of information technology.

3.      Steven Filling - Steven Filling teaches Information Systems and Management Control Systems at California State University , Stanislaus. Steven practiced accounting and systems analysis prior to becoming an academic. He is currently involved in public budgeting and faculty union activities.

4.      Marty Freedman - Marty Freedman is a Professor of Accounting at Towson University and co-editor of Advances in Environmental Accounting and Management. He has published over thirty papers mostly focusing on social and environmental responsibility. He has also published a book on air and water pollution.

5.      Soon Nam Kim - Soon Nam Kim is a lecturer in accounting at the University of Wollongong . Her major teaching areas are first and second year management and financial accounting. Her research interests are cultural issues in accounting, in particular race/ethnicity and gender issues, issues in accounting education, international accounting, and business issues. She has published a number of articles in internationally referred journals.

6.      Linda Ruchala  - Linda Ruchala is an associate Professor of Accountancy at the University of Nebraska-Lincoln. Her areas of interest are managerial accounting, accounting information systems, and accounting in the public interest.

7.      Bill Schwartz - Bill Schwartz is the dean of Indiana University South Bend. He is the co-editor of Advances in Accounting Education, and has served as past chair of Teaching and Curriculum for the America Accounting Association and past managing editor of Research on Accounting Ethics.

8.      Tony Tinker - Tony Tinker is Professor of Accounting at Baruch College at the City University of New York and visiting Professor at Leicester University and the University of South Australia . He is co-editor of Critical Perspectives on Accounting and the Accounting Forum. He has appeared on CNN, the BBC, and NPR, and has published several books and numerous articles.

9.      Paul F. Williams - Paul F. Williams is a Professor of Accounting at North Carolina State University . He served as past chair of the Public Interest section of the American Accounting Association and currently is associate editor of Accounting and the Public Interest.