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 improv