Rotten to the Core --- Part 2
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Rotten to the Core --- Part 1
|http://www.trinity.edu/rjensen/FraudRotten.htm

Bob Jensen at Trinity University 

 


Timeline of Financial Scandals, Auditing Failures, and the Evolution of International Accounting Standards ---- http://www.trinity.edu/rjensen/FraudCongress.htm#DerivativesFrauds  (to view on a new page)
For a faster scroll down this same page --- Click Here


Introductory Quotations (including Eliot Spitzer's Case Book)
See http://www.trinity.edu/rjensen/FraudRotten.htm#Quotations

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

Can You Train Business School Students To Be Ethical? The way we’re doing it now doesn’t work. We need a new way
See http://www.trinity.edu/rjensen/FraudRotten.htm#CollegeTaught

Securities Fraud History and Highlights
See http://www.trinity.edu/rjensen/FraudRotten.htm#SecuritiesFraud

The Most Criminal Class Writes the Laws 
See http://www.trinity.edu/rjensen/FraudRotten.htm#Lawmakers

Accountant and Auditor Scandals 
See http://www.trinity.edu/rjensen/FraudRotten.htm#Accountants  

Private Equity Crooks
See http://www.trinity.edu/rjensen/FraudRotten.htm#PrivateEquity

The Vultures Feeding on Insolvency 
See http://www.trinity.edu/rjensen/FraudRotten.htm#Vultures

Insolvent Vultures Feeding on Creditors and Taxpayers
See http://www.trinity.edu/rjensen/FraudRotten.htm#MutualFunds

Mutual Fund, Index Fund, and Insurance Company Scandals  
See http://www.trinity.edu/rjensen/FraudRotten.htm#PensionFundConsulting

Investment Banking, Banking, Brokerage, Banking, and Security Analysis Scandals
See http://www.trinity.edu/rjensen/FraudRotten.htm#InvestmentBanking

Peter, Paul, and Barney: An Essay on 2008 U.S. Government Bailouts of Private Companies ---
See http://www.trinity.edu/rjensen/2008Bailout.htm

The Pension Fund Consulting Racket
See http://www.trinity.edu/rjensen/FraudRotten.htm#PensionFundConsulting

Playing Favorites:  Why the Fed Lets Banks Off Easy on Corporate Fraud  
See http://www.trinity.edu/rjensen/FraudRotten.htm#Banking

From Enron to Earnings Reports, How Reliable is the Media's Coverage?
See http://www.trinity.edu/rjensen/FraudRotten.htm#Media

Insurance Company Scandals  
See http://www.trinity.edu/rjensen/FraudRotten.htm#Insurance

Medicare and Medicaid Fraud  
See http://www.trinity.edu/rjensen/FraudRotten.htm#Medicare 

The Crookest of them All:  Lawyers
See http://www.trinity.edu/rjensen/FraudRotten.htm#Lawyers

Credit Rating Agencies
See http://www.trinity.edu/rjensen/FraudRotten.htm#CreditRatingAgencies

Bob Jensen's threads on how credit card companies are cheating you are at http://www.trinity.edu/rjensen/FraudReporting.htm#FICO

Accelerated share repurchase (ASR) Manipulation of Earnings-Per-Share (EPS)
See http://www.trinity.edu/rjensen/FraudRotten.htm#ASRs

Avoid Investing in Nations Ridden With Crime 
See http://www.trinity.edu/rjensen/FraudRotten.htm#InternationalCrime 

Real Estate Fraud  
See  http://www.trinity.edu/rjensen/FraudRotten.htm#RealEstateFraud

Many Companies Avoided Taxes Even as Profits Soared in Boom 
See http://www.trinity.edu/rjensen/FraudRotten.htm#TaxAvoidance

Billionaires & Accounting Scandals
See http://www.trinity.edu/rjensen/FraudRotten.htm#Billionaires

Ponzi Schemes Where Bernie Madoff Was King

Exploiting the Poor

Fraud at the World Bank

Fraud Around the World  

A Topic for Class Debate 

Women of Wall Street Get Their Day in Court  

Derivative Financial Instruments and "Fairness Opinion" Frauds

LTCM:  The Trillion Dollar Bet

Government Subsidies and Pork Barrels 
U.S. Government Accountability (Governmental Accounting)

The End of Wall Street? 

 

Video: Fora.Tv on Institutional Corruption & The Economy Of Influence ---
http://www.simoleonsense.com/video-foratv-on-institutional-corruption-the-economy-of-influence/

Global Corruption (in legal systems) Report 2007 --- http://www.transparency.org/content/download/19093/263155

Accounting Education Shares Some of the Blame --- http://www.trinity.edu/rjensen/FraudProposedReforms.htm#AccountingEducation 

Charity Frauds --- http://www.trinity.edu/rjensen/FraudReporting.htm 

Bob Jensen documents on derivative financial instruments are linked at 
http://www.trinity.edu/rjensen/caseans/000index.htm
 

Bob Jensen's glossary on derivative financial instruments is at 
http://www.trinity.edu/rjensen/acct5341/speakers/133glosf.htm
 

Monthly Updates on the Above Fraud Categories --- http://www.trinity.edu/rjensen/FraudUpdates.htm 

The Worst Fraudsters
"Who's the Worst? Expanded to More Categories," Dennis Elam, Elam Blog, October 30, 2013 ---
http://www.professorelam.typepad.com/

From the IRS
IRS Criminal Investigation Issues Fiscal 2012 Report, IR-2013-50, May 10, 2013 ---
http://www.irs.gov/uac/Newsroom/IRS-Criminal-Investigation-Issues-Fiscal-2012-Report

Notable Fraudsters --- http://en.wikipedia.org/wiki/Fraud#Notable_fraudsters

Fraud Detection and Reporting --- http://www.trinity.edu/rjensen/FraudReporting.htm 

Bob Jensen's American History of Fraud ---  http://www.trinity.edu/rjensen/415wp/AmericanHistoryOfFraud.htm

Bob Jensen's Other Fraud Documents --- http://www.trinity.edu/rjensen/fraud.htm 

White Collar Fraud Site --- http://www.whitecollarfraud.com/
Note the column of links on the left.

Online Searching for Law, Accounting, and Finance --- http://securities.stanford.edu/

Stanford University Law School Securities Class Action Clearinghouse --- http://securities.stanford.edu/

Securities Law Archives --- http://www.bespacific.com/mt/archives/cat_securities_law.html

Securities and Exchange Commission --- http://www.sec.gov/
Division of Corporation Finance: Current Accounting and Disclosure Issues --- http://www.sec.gov/divisions/corpfin/acctdisc_old.htm

The Heroes of Financial Fraud, The Atlantic, April 2009 --- http://meganmcardle.theatlantic.com/archives/2009/04/the_heroes_of_financial_fraud.php

History of Fraud in America ---  http://www.trinity.edu/rjensen/415wp/AmericanHistoryOfFraud.htm

Rotten to the Core --- http://www.trinity.edu/rjensen/FraudRotten.htm

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


I'm giving thanks for many things this Thanksgiving Day on November 22, 2012, including our good friends who invited us over to share in their family Thanksgiving dinner. Among the many things for which I'm grateful, I give thanks for accounting fraud. Otherwise there were be a whole lot less for me to study and write about at my Website ---


Some of the many, many lawsuits settled by auditing firms can be found at http://www.trinity.edu/rjensen/Fraud001.htm

Recent Financial Reporting and Disclosure Initiatives
  • Initiative to Address Improper Earnings Management
  • Rules Governing Independence of the Accounting Profession
  • New Rules for Audit Committees and Reviews of
    Interim Financial Statements
  • Materiality in the Preparation or Audit of Financial Statements
    (SAB 99)
  • Restructuring Charges, Impairments, and Related Issues (SAB 100)
  • Interpretive Guidance on Revenue Recognition (SAB 101)
  • Proposed Rule for Disclosure about Valuation and Loss Accruals, Long-Lived Assets
  • Proposed Rule for Guarantors and Related Issuers
  • Matters Involving Auditor Independence
  • Recent Enforcement Action -- America Online, Inc.

Other Commission Rules and Proposals Affecting Registration
and Reporting

  • Interpretive Release on the Use of Electronic Media
  • Regulation of Takeovers and Security Holder Communications
  • EDGAR

Current Accounting and Disclosure Issues

  • Segment Disclosure
  • Issues Associated With SFAS 133, Accounting for Derivative Instruments and Hedging Activities
  • Amortization Periods Selected for Goodwill
  • Accounting for Intangibles Relating to Customer Relationships
  • Purchase Adjustments to Acquired Company's Loss Accruals
  • Allowance for Loan Losses
  • Internal Costs Associated with an Acquisition
  • Redeemable Securities and "Deemed Liquidation Events"
  • Changes in Functional Currency
  • Effects of Changes to Financial Statements Filed with the Commission in an IPO
  • Market Risk Disclosures
  • Revenue and Cost Recognition in Co-Marketing Arrangements
  • Write-Offs of Prepayments for Services, Occupancy or Usage
  • Cost or Equity Method of Accounting
  • Accounting for Extended Warranty Plans
  • SFAS 45 Guidance Limited to Franchise Agreements
  • Disclosures about "Targeted Stock"
  • Gain on Sale or Securitization of Financial Assets
  • Combining Companies in a Pooling of Interests
  • Issues in the Extractive Industry

Internationalization of the Securities Markets

  • Foreign Issuers in the U.S. Market
  • International Accounting Standards
  • International Disclosure Standards – Amendments to Form 20-F

Other Information About the Division of Corporation Finance
and Other Commission Offices and Divisions

  • The SEC Website and Other Information Outlines
     
  • Corporation Finance Staffing and Phone Numbers
     
  • Division Employment Opportunities for Accountants

Business schools, eager to impart ethics, are paying white-collar felons to recite the error of their ways

"Using Ex-Cons to Scare MBAs Straight," by Porter, Business Week, April 24, 2008 --- Click Here

Bob Jensen's threads on white collar crime include the following links:

http://www.trinity.edu/rjensen/Fraud.htm

http://www.trinity.edu/rjensen/Fraud001.htm

http://www.trinity.edu/rjensen/FraudUpdates.htm


Question
Where were (are) the lawyers in the recent corporate governance and investment scandals?
Report of the Task Force on the Lawyer's Role in Corporate Governance, New York City Bar, November 2006 --- http://online.wsj.com/public/resources/documents/WSJ-CORP-GOV-FINAL_REPORT.pdf
Bob Jensen's threads on corporate governance are at http://www.trinity.edu/rjensen/fraud001.htm#Governance

January 29, 2008 message from Sikka, Prem N [prems@essex.ac.uk]

Dear Bob.

Here is an item for your website.

I have been writing regular blogs for The Guardian, a UK national newspaper. The articles are available at http://commentisfree.guardian.co.uk/prem_sikka/index.html and offer a critical commentary on business and accountancy matters. For three days after each article the website takes readers' comments and colleagues are welcome to add comments, critical or otherwise. The most recent article appeared on 29 January 2008.

There is now also an extensive database of corporate and accountancy misdemeanours on the AABA website ( http://www.aabaglobal.org <https://exchange5.essex.ac.uk/exchweb/bin/redir.asp?URL=http://www.aabaglobal.org/> ) and may interest scholars, students, journalists and citizens concerned about the abuse of power.

Regards

Prem Sikka
Professor of Accounting
University of Essex
Colchester, Essex CO4 3SQ
UK
Office Tel: +44(0)1206 873773
Office Fax: +44 (01206) 873429

Jensen Comment
I added Professor Sikka's message to the following sites:

http://www.trinity.edu/rjensen/FraudUpdates.htm

http://www.trinity.edu/rjensen/Fraud.htm

http://www.trinity.edu/rjensen/Fraud001.htm

http://www.trinity.edu/rjensen/FraudCongress.htm


  • Ponzi Schemes Where Bernie Madoff is King

    Charles Ponzi (1882-1949) --- http://en.wikipedia.org/wiki/Charles_Ponzi
    Ponzi Frauds --- http://en.wikipedia.org/wiki/Ponzi_game


    Questions
    Do your students know the difference between mutual funds and hedge funds?
    Do your students really understand how Ponzi schemes work?
    Start with (gasp) Wikipedia.

    "Former Christian radio host charged in Ponzi scheme," by Stephen Thompson, St. Petersburg Tribune, January 30, 2013 ---
    http://tbo.com/pinellas-county/former-christian-radio-host-charged-in-ponzi-scheme-20140130/

    Gary L. Gauthier, the former host of a Saturday morning Christian radio show called “It’s God’s Money,” is one of two men arrested this month in a Ponzi scheme that defrauded 38 people in the Tampa Bay area of $6 million, according to court documents.

    Gauthier, 64, who now lives in Okemos, Mich., was arrested last week in Tampa, according to the Florida Department of Law Enforcement. David George Dreslin, 54, of Seminole, was arrested earlier in the month, the FDLE reported.

    The two are charged with one count of racketeering, one count of conspiring to engage in a pattern of racketeering activity, two counts of organized fraud, six counts of the sale of an unregistered security, six counts of the sale of a security by an unregistered dealer and two counts of security fraud.

    Dreslin attracted people through his accounting practice, and Gauthier’s victims were the listeners of his Tampa radio shows, “It’s God’s Money” and “It’s All About Florida Real Estate,” the documents say.

    They were, for a time, broadcast on Tampa radio station WTBN and WGUL. General manager Barbara Yoder didn’t return a telephone call Wednesday for comment.

    “A majority of the victims stated they relied upon the statements made by Gauthier because they were made on a Christian radio station,” according to the document charging the pair.

    “Most of the victims were elderly, ... over the age of 60,” the document says.

    Denise Ferrari, a 62-year-old retired dental technician and postal worker living in Clearwater, was one of the victims. She said she was persuaded to deposit her $86,000 IRA in a company set up by the two men, and now she’s suing them to get the money back.

    “They put this guy on the air,” Ferrari said. “Folks called in and said, ‘We don’t have to work again because we invested in Gary Gauthier.’

    “I was shocked to find out it was a Ponzi scheme,” Ferrari said. “How was I to know? How were the victims to know?”

    The scheme occurred from April 20, 2005, through Aug. 15, with the men soliciting people in Pasco, Pinellas and Hillsborough counties.

    On his radio shows, Gauthier provided a telephone number listeners could call so he could meet them at their homes, a restaurant or in Dreslin’s office, the documents state.

    The people were encouraged to invest tens of thousands of dollars in various real estate development projects, the documents say. They were told they would see a return of 8 percent to 40 percent in a relatively short period, the documents state.

    But in most cases they saw no return on their investment, and “as a result, victims have lost their homes and many have lost their entire retirement,” the documents say.

    “Gauthier and Dreslin convinced them to liquidate their annuities, cash out their retirement accounts and, in some instances, to take cash out of the equity of their homes to invest in various pre-construction or existing real estate ventures,” the charging document states.

    And contrary to what clients were told, Gauthier and Dreslin didn’t put up their own money for the ventures, the documents state.

    Continued in article

    Bob Jensen's threads on Ponzi frauds ---
    http://www.trinity.edu/rjensen/FraudRotten.htm#Ponzi

    Bob Jensen's Fraud Updates ---
    http://www.trinity.edu/rjensen/FraudUpdates.htm


    Deloitte Auditors Fail to Detect $350 Million Ponzi Fraud
    "Aequitas investors file suit against Tonkon Torp, Deloitte," by Jeff Manning, The Oregonian, April 4, 2016 ---
    http://www.oregonlive.com/business/index.ssf/2016/04/aequitas_investors_file_suit_a.html

    Investors burned in the flameout of Aequitas Capital Management have filed suit against Portland law firm Tonkon Torp and accounting giant Deloitte & Touche, claiming the firms enabled the massive Ponzi scheme allegedly masterminded by the Lake Oswego financial company.

    "Investors trusted Aequitas and their trust was abused," said Keith Ketterling, of the Stoll Berne Lokting & Shlachter firm in Portland. "The law makes the lawyers and accountants responsible to the same extent as Aequitas, because these professionals are the gatekeepers, and their services lend credibility to the investments."

    Tonkon Torp, one of the most respected corporate law firms in town, for several years represented Aequitas and helped prepare prepare financial documents for investors that were materially false, investors allege.

    "The Aequitas securities could not have been sold without the legal services that Tonkon provided," investors claim in the new complaint.

    Deloitte prepared the 2014 and 2015 audited financial statements for Aequitas, which painted a reassuring portrait of Aequitas' financial strength. Deloitte offered a so-called "unqualified" opinion in its 2014 audit that Aequitas' financials fairly and accurately represented the company's financial condition. The U.S. Securities and Exchange Commission now claims that Aequitas by 2014 was little more than a large Ponzi scheme, reliant on new investor money to cover its expenses.

    The new complaint, filed Monday in U.S. District Court in Portland, is likely the first of many investor lawsuits. The commission's March 10 lawsuit accused Aequitas and three top executives of concealing the catastrophic condition of the company even as it continued to raise more than $350 million from investors.

    Continued in article


    "PwC in $55 million settlement with Madoff feeder fund investors," by Jonathan Stemple, Routers, January 7, 2016 ---
    http://www.reuters.com/article/us-pwc-madoff-settlement-idUSKBN0UL03N20160107

    Bob Jensen's threads on the Madoff Ponzi scandal ---
    http://www.trinity.edu/rjensen/FraudRottenPart2.htm#Ponzi 

    Bob Jensen's threads on PwC ---
    http://www.trinity.edu/rjensen/Fraud001.htm


    "MIT Sloan Kept Madoff-Linked Professor on Staff for Years After Fraud," by Natalie Kitroeff, Bloomberg Businessweek, August 14, 2014 ---
    http://www.businessweek.com/articles/2014-08-14/mit-sloan-didnt-fire-professor-who-funneled-cash-to-madoff-scheme 

    Prosecutors announced that Gabriel Bitran, a former associate dean at Massachusetts Institute of Technology’s Sloan School of Management, has agreed to plead guilty to criminal charges of conspiracy to commit fraud for using a hedge fund to secretly funnel investors’ cash into Bernard Madoff’s Ponzi scheme. His son, Marco, will also plead guilty in the case. Bitran’s misdeeds were made public as early as 2009, yet he stayed on Sloan’s faculty until 2013.

    Bitran and his son paid almost $5 million in April 2012 to settle Securities and Exchange Commission charges that they lied to investors. Years earlier, a Reuters report detailed his fund’s involvement in the Madoff scheme. Bitran remained on Sloan’s staff until he retired in January 2013, teaching classes on operations and management. His lawyer did not return a call seeking comment.

    The elder Bitran was sued unsuccessfully in 1992 for sexual harassment by a woman who worked as an assistant in his office on Sloan’s campus. While her case failed, the decision spurred widespread protest and prompted the school to overhaul its policies on such incidents.

    Continued in article

    Bob Jensen's Fraud Updates ---
    http://www.trinity.edu/rjensen/FraudUpdates.htm


    The Worst Sack Ever on John Elway (former All-Pro Quarterback in the Mile-High City)
    Elway Got Schemered!
    Stanford Graduates Should Know Better
    "John Elway Invested $15 MILLION With Alleged Ponzi Schemer," Huffington Post, October 14, 2010 ---
    http://www.huffingtonpost.com/2010/10/14/john-elway-invested-15-mi_n_762663.html

    John Elway Invested $15 MILLION With Alleged Ponzi Schemer

    diggfacebook Twitter stumble reddit del.ico.us What's Your Reaction? .Amazing Inspiring Funny Scary Hot Crazy Important Weird Read More: Elway 15 Million, John Elway, Mitchell Pierce, Ponzi Scheme, Sean Michael Mueller, Sean Mueller, Denver News 10 views Get Denver Alerts Email Comments 17 DENVER — Former Denver Broncos quarterback John Elway and his business partner gave $15 million to a hedge-fund manager now accused of running a Ponzi scheme.

    The Denver Post reported Thursday that Elway and Mitchell Pierce filed a motion saying they wired the money to Sean Michael Mueller in March. They said Mueller agreed to hold the money in trust until they agreed on where it would be invested.

    A state investigator says 65 people invested $71 million with Mueller's company over 10 years and it only had $9.5 million in assets in April and $45 million in liabilities.

    Elway's filing asks that the court put their claims ahead of others so they can collect their money first. His lawyer declined to comment.

    Jensen Comment
    It's hard to feel sorry for rich people who play in games without rules (hedge funds)
    Better to play in games with rules and stand behind 325 lb linemen with missing teeth, BO, and noses that look like corkscrews.

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

    Bob Jensen's threads on Hedge Funds are under the H-term at
    http://www.trinity.edu/rjensen/acct5341/speakers/133glosf.htm
    Note that hedge funds may have nothing to do with hedging.


     

    "SEC Charges Texas Man in Bitcoin-Related Ponzi Fraud:  Agency Warns Investors to Be Wary of Schemes Tied to Virtual Currencies," by Robin Sidel, The Wall Street Journal, July 23, 2013 ---
    http://online.wsj.com/article/SB10001424127887324144304578624221093071466.html?mod=djemCFO_h 

    Regulators on Tuesday charged a Texas man with running a Ponzi scheme promising big returns on the virtual currency bitcoin, and warned individual investors to be wary of similar frauds.

    The move by the Securities and Exchange Commission is the latest action by regulators to rein in suspicious activity associated with virtual currencies.

    "We are concerned that the rising use of virtual currencies in the global marketplace may entice fraudsters to lure investors into Ponzi and other schemes in which these currencies are used to facilitate fraudulent, or simply fabricated, investments or transactions," the SEC said in an investor alert.

    In recent months federal and state agencies have started to clamp down on exchanges that trade bitcoin, the most popular virtual currency, by requiring them to follow the same guidelines as traditional money-transmission companies like Western Union Co. WU -0.40% and MoneyGram International Inc. MGI -1.25%

    Bitcoin is a decentralized currency that can be created or "mined" by users. It also can be traded on a number of exchanges or swapped privately among users. Most of the currency is traded on a Tokyo-based exchange called Mt. Gox, where one bitcoin was valued Tuesday at roughly $95.

    The SEC on Tuesday charged Trendon T. Shavers, 30 years old, with raising more than $4.5 million worth of bitcoin from investors who were "falsely" promised a weekly interest rate of 7%. Mr. Shavers, of McKinney, Texas, was the founder and operator of a website called Bitcoin Savings and Trust.

    Mr. Shavers couldn't be reached for comment.

    The civil complaint, filed in federal court in Texas, cites comments that Mr. Shavers posted on an online bitcoin forum. They include messages posted by Mr. Shavers under the Internet name "pirateat40" that played down risks associated with the investment.

    Mr. Shavers offered and sold the investments from at least September 2011 to September 2012, according to the complaint. Mr. Shavers sold the investments to at least 66 investors, including those in Connecticut, Hawaii, Illinois, Louisiana, Massachusetts, North Carolina and Pennsylvania, according to the complaint.

    The complaint describes Bitcoin Savings and Trust as a "sham and a Ponzi scheme" in which Mr. Shavers used bitcoin raised from new investors to pay the returns on the outstanding investments.

    The SEC also accused Mr. Shavers of using nearly $150,000 of the proceeds for personal expenses, including "rent, car-related expenses, utilities, retail purchases, casinos and meals."

    Mr. Shavers shut down the Bitcoin Savings and Trust website last August.

    Continued in article

    Bob Jensen's Fraud Updates ---
    http://www.trinity.edu/rjensen/FraudUpdates.htm


    Are Herbalife's financial statements nutritious?

    Grumpy Old Accountants
    Tony promised he would notify the AECM about his new postings.
    I think he's forgetting his promise.
    the Grumpy Old Accountants Blog carries on in the style of Abe Briloff. For decades Abe grubbed around the details of financial statements to find violations of accounting standards, auditing standards, and reporting integrity in general. Tony is trying to carry on alone with this blog --- which is a huge job because it's not easy to pour over financial statements at a professional level.

    "What Do Herbalife's Financials Tell Us?," Anthony H. Catanach Jr., Grumpy Old Accountants, January 30, 2013 ---
    http://grumpyoldaccountants.com/blog/2013/1/30/what-do-herbalifes-financials-tell-us 

    Once again I'm asking Tony to let us know when he posts a new tidbit on the GOA Blog.


    "CPA convicted for role in $40 million Ponzi scheme," WCNC.com, February 11, 2013 ---
    http://www.wcnc.com/news/business/CPA-convicted-for-role-in-40-million-Ponzi-scheme--190747591.html

    CHARLOTTE, N.C. (AP) -- An accountant has been convicted for his role in a $40 million Ponzi scheme that defrauded investors in North Carolina, Virginia and Ohio.

    A federal jury in Charlotte convicted Jonathan D. Davey of Newark, Ohio, on four counts of investment fraud conspiracy and tax evasion. Prosecutors say Davey administered several hedge funds in the Black Diamond Ponzi scheme, soliciting more than $11 million from victims in the case.

    The 48-year-old accountant, who was convicted Friday, is the 11th defendant convicted in the 2007 fraud, which prosecutors say deprived about 400 victims of more than $40 million. Prosecutors say Davey used a shell company in Belize to funnel money toward construction of his mansion in Ohio.

    Davey faces a maximum sentence of 50 years in prison and $1 million in fines.

    Bob Jensen's threads on Ponzi frauds ---
    http://www.trinity.edu/rjensen/FraudRotten.htm#Ponzi

    Bob Jensen's Fraud Updates ---
    http://www.trinity.edu/rjensen/FraudUpdates.htm

     


    "Scottsdale accountant indicted in $66 million ponzi scheme," by Peter Corbett, azcentral.com, April 19. 2012 ---
    http://www.azcentral.com/community/scottsdale/articles/2012/04/19/20120419scottsdale-accountant-indicted-million-ponzi-scheme-brk.html

    A federal grand jury in Phoenix has returned a 102-count indictment against a former Scottsdale certified public accountant on charges he operated a $66 million ponzi scheme.

    The indictment of Daniel Wise, 55, was announced Thursday by the U.S. Attorney's Office for Arizona. He is accused of mail and wire fraud, and money laundering.

    "The U.S. Attorney's Office will continue to work with our law enforcement partners to investigate and prosecute those who prey on the public for personal financial gain," said Ann Birmingham Scheel, acting U.S. Attorney for Arizona.

    Read more: http://www.azcentral.com/community/scottsdale/articles/2012/04/19/20120419scottsdale-accountant-indicted-million-ponzi-scheme-brk.html#ixzz1sbYPzZih

    The indictment alleges Wise fraudulently induced victims to invest $66 million with false promises of high-yield returns by making short-term, high-interest, hard-money loans in real estate ventures. He is accused of using a web of bank accounts and entities from June 2005 to December 2008 to deceive his clients.

    The indictment alleges that Wise did not make the investments but instead operated a ponzi scheme by using money obtained from newer victims to pay off older victims.

     


    "The Stanford Sentence SEC examiners first flagged Stanford way back in the 1990s," The Wall Street Journal, June 15, 2012 ---
    http://professional.wsj.com/article/SB10001424052702303734204577466672525877312.html?mg=reno64-wsj#mod=djemEditorialPage_t

    Convicted Ponzi schemer R. Allen Stanford was sentenced Thursday to 110 years in federal prison for his $7 billion fraud. Stanford victimized thousands of individual investors to fund a lifestyle of private jets and island vacation homes. Now the question is whether there will be anything left at all for these victims once authorities in jurisdictions around the world finish sifting through the wreckage.

    Stanford "stole more than millions. He stole our lives as we knew them," said victim Angela Shaw, according to Reuters. Certificates of deposit issued by a Stanford bank in Antigua promised sky-high returns but succeeded only in destroying the savings of middle-class retirees. More than three years after U.S. law enforcement shut down the Stanford outfit, victims have recovered nothing.

    A receiver appointed by a federal court, Ralph Janvey, has collected $220 million from the remains of Stanford's businesses but has already used up close to $60 million in fees for himself and other lawyers, accountants and professionals, plus another $52 million to wind down the Stanford operation.

    And then there's the Securities and Exchange Commission, which didn't charge Stanford for years even after its own examiners raised red flags as early as the 1990s. The SEC has lately pursued a bizarre attempt at blame-shifting, trying to get the Securities Investor Protection Corporation to cover investor losses. Even the SEC must know that SIPC doesn't guarantee paper issued by banks in Antigua—or anywhere else for that matter.

    SEC enforcers should instead focus on catching the next Allen Stanford. Careful investors should expect that they won't.

    Bob Jensen's threads on Ponzi schemes are at
    http://www.trinity.edu/rjensen/FraudRotten.htm#Ponzi

    R. Allen Stanford --- http://en.wikipedia.org/wiki/Allen_Stanford

    "R. Allen Stanford Guilty in Ponzi Scheme," by Daniel Gilbert and Tom Fowler, The Wall Stre3et Journal, March 6, 2012 --- Click Here
    http://online.wsj.com/article/SB10001424052970203458604577265490160937460.html?mod=WSJ_hp_LEFTWhatsNewsCollection

    After a criminal case that dragged on for nearly three years, a jury of eight men and four women on Tuesday convicted Mr. Stanford on 13 of the 14 charges brought by prosecutors, including fraud, obstructing investigators and conspiracy to commit money laundering. The verdict is a victory for the U.S. government, which targeted the chairman of Stanford Financial Group as part of a crackdown on white-collar crime following the financial crisis.

    He faces a maximum of 230 years in prison. Mr. Stanford's attorneys, while still under a court order to not discuss the case, told reporters they would appeal but didn't specify on what grounds. Prosecutors declined to comment.

    Robert Khuzami, enforcement director of the Securities and Exchange Commission, said in a statement, "Today's guilty verdicts send a resounding message that those who violate the law and obstruct SEC investigations will be held accountable. We applaud the skill and tenacity of the prosecutors handling the case."

    The verdict, coming on the fourth full day of deliberations after a monthlong trial, marks a remarkable downfall for Mr. Stanford, 61 years old, who rose from owning a gym in Texas to becoming a billionaire knighted in Antigua. As the verdict was read, Mr. Stanford, wearing a dark suit and open-necked shirt, turned to family members sitting in the courtroom and appeared to mouth the words, "It's OK." [stanford1] Reuters

    2012: Stanford enters a Houston court Tuesday.

    On Monday, the judge ordered jurors to continue deliberating after they said they couldn't reach a unanimous verdict on all 14 criminal counts.

    Prosecutors estimated Mr. Stanford's $7.1 billion fraud was among the largest in history, but it was overshadowed by an even greater financial crime: the $17.3 billion Ponzi scheme orchestrated by financier Bernard Madoff, who pleaded guilty in 2009.

    The end of Mr. Stanford's criminal case could allow investors to attempt to recover hundreds of millions of dollars from his accounts and the assets of Stanford Financial Group. A judge has placed on hold the civil suit brought against him by the SEC while the criminal case is pending. An appeal of the verdict, however, may delay investors' recovery efforts.

    Cassie Wilkinson, a Stanford Financial investor, said she was "relieved, happy and sad," about the verdict. "I feel sorry for his family, for his mother," she said, referring to Sammie Stanford, the 81-year-old who has been in the courtroom every day since deliberations began. "It's a tragic loss for so many families, for tens of thousands of investors."

    After the verdict, jurors began to hear the case on the Justice Department's efforts to seize funds in bank accounts controlled by Mr. Stanford, estimated to hold more than $300 million. The SEC, in a separate civil action, could ask a judge for permission to move forward with its case if it believes there are additional assets to recover.

    Continued in article

    Bob Jensen's threads on Ponzi fraud ---
    http://www.trinity.edu/rjensen/FraudRotten.htm#Ponzi


    Interview With Diana B. Henriques, author of The Wizard of Lies:
    "Questions and Answers about 'The Wizard of Lies,' Knowledge@Wharton, August 15, 2011 ---
    http://knowledge.wharton.upenn.edu/article.cfm?articleid=2827

    Bob Jensen's threads on the Madoff Ponzi Fraud Scandal ---
    http://www.trinity.edu/rjensen/FraudRotten.htm#Ponzi


    From The Wall Street Journals Accounting Weekly Review on March 28, 2014

    Jury Finds Staff Aided Madoff Con
    by: Christopher M. Matthews
    Mar 25, 2014
    Click here to view the full article on WSJ.com
     

    TOPICS: Fraud, Ponzi Schemes

    SUMMARY: In contrast to Bernard L. Madoff's statements that he alone concocted the massive, long-running Ponzi scheme at his investment firm, "jurors found five [of his] former employees...guilty of aiding and hiding the fraud...." Two computer programmers, two portfolio managers and a former operations director all range in ages from 48 to 67 and face decades in prison "on a total of 31 charges ranging from securities fraud to conspiring to defraud investors." The programmers created programs to randomly generate false documents and the portfolio managers "backdated nonexistent trades, prosecutors said." Former CFO Frank DiPascali Jr. aided the prosecution in exchange for a recommendation for a more lenient sentence from his 2009 guilty plea. He testified, for example, that he once saw two of the defendants make specific efforts to create a document for a KPMG auditor which appeared old and used rather than newly printed which it in fact was.

    CLASSROOM APPLICATION: The article may be used to provide closure on some aspects of the Madoff Ponzi scheme case in a financial reporting, auditing, or ethics class.

    QUESTIONS: 
    1. (Advanced) What is a Ponzi scheme? What was the scale of the Ponzi scheme which Bernard L. Madoff has admitted to running over a long period of time?

    2. (Introductory) What activities did CFO DiPascali admit to doing and observing which produced fraudulent records in support of the Ponzi scheme?

    3. (Introductory) What were Ms. Bongiorno and Mr. Bonventre's arguments about their actions and claims to innocence?

    4. (Advanced) If you had worked at the Madoff firm and became suspicious of the activity you observed, what would your options be in reacting to the situation?
     

    Reviewed By: Judy Beckman, University of Rhode Island
     

    RELATED ARTICLES: 
    Aide Saw Madoff as 'Big Brother'
    by Christopher M. Matthews
    Feb 24, 2014
    Page: ##

    "Jury Finds Staff Aided Madoff Con," by Christopher M. Matthews, The Wall Street Journal, March 25, 2014 ---
    http://online.wsj.com/news/articles/SB10001424052702304679404579459551977535482?mod=djem_jiewr_AC_domainid

    Bernard L. Madoff has maintained for years that his decadeslong Ponzi scheme was a one-man show. On Monday, a jury concluded instead that it was a team effort.

    Jurors found five former employees of Mr. Madoff guilty of aiding and hiding the fraud in a trial that painted the money manager's Manhattan offices as a hive of illegal activity, where employees cooked up lies and manufactured fake documents to keep afloat a scam that ultimately cost investors $17 billion.

    Computer programmers Jerome O'Hara, 51 years old, and George Perez, 48, were convicted in federal court in Manhattan of creating phony customer accounts, while portfolio managers Annette Bongiorno, 66, and JoAnn Crupi, 53, were convicted of concocting phony trading records. Daniel Bonventre, 67, a former operations director for Mr. Madoff, helped gin up false books and records, the jury found.

    The findings reshape the narrative from a crime that has been tightly linked in the public's consciousness with one man to a group effort that transpired within the firm's offices in the iconic Lipstick building in midtown Manhattan.

    Mr. Madoff directed the scheme from his office on the 19th floor, prosecutors told jurors, but much of the work done to conceal it took place in the secretive offices of the 17th floor, where the investment-advisory business was run. On that floor, dubbed "House 17" and accessible only with a security card, Messrs. O'Hara and Perez created computer programs to randomly generate false documents, while Ms. Bongiorno and Ms. Crupi backdated nonexistent trades, prosecutors said.

    Mr. Bonventre, 67 years old, worked on the market-making business on the 18th and 19th floors, along with Mr. Madoff's sons Mark and Andrew and brother Peter. But prosecutors said Mr. Bonventre was cooking the books and funneling money to the investment-advisory business.

    According to several jurors speaking outside the courthouse after their verdicts, their decision wasn't even close.

    "How could Bernie be the only one that could pull this off?" said juror Sheila Amato, a teacher in Rockland County, N.Y. "He's the mastermind. They were like his soldiers."

    "They were in it for so long, that maybe the truth became a blur," she added.

    The result, which followed four days of deliberations, caps a nearly six-month trial and hands prosecutors a win in their only attempt to bring a Madoff case before a jury. Mr. Madoff pleaded guilty in 2009.

    The defendants, who are expected to appeal, each face decades in prison on a total of 31 charges ranging from securities fraud to conspiring to defraud investors. They are due to be sentenced at the end of July.

    The trial was one of the longest white-collar trials in recent years and was difficult for all involved, including the jurors, one of whom fell sick during the deliberations and was excused.

    As they listened to the verdicts, most of the defendants sat grim-faced, saying nothing. Ms. Crupi repeatedly shook her head during the reading, while Ms. Bongiorno's husband stared at the ceiling with his arms crossed.

    The Madoff fraud has wreaked havoc on thousands of investors across the globe, led to the downfall of prominent investors, including the late billionaire Jeffry Picower, and sparked a hail of criticism against regulators who failed to catch the fraud, which dates as far back as the 1970s.

    Mr. Madoff, who was sentenced nearly five years ago to 150 years in prison, has insisted he carried out the long-running scheme on his own. But during the trial, prosecutors turned to an array of witnesses, including several of Mr. Madoff's former employees, to establish that wasn't the case.

    The government's main witness was Frank DiPascali Jr., the former chief financial officer who worked with Mr. Madoff for 33 years.

    Mr. DiPascali was on the stand for more than a month and in sometimes emotional testimony implicated all of the defendants, telling jurors he worked with all five to produce fraudulent records.

    In one instance, Mr. DiPascali testified he saw Messrs. O'Hara and Perez and Ms. Crupi putting a new fake document in the fridge to cool it down after it came off the printer and then throwing it around like a "medicine ball" to make it look used before turning it over to a KPMG auditor who had arrived to collect it.

    Mr. DiPascali, 57 years old, pleaded guilty in 2009 and faces a maximum of 125 years in prison. He is confined to his home as part of a government cooperation agreement that could result in a recommendation for a more lenient sentence.

    Other testimony focused on the alleged spending habits of the defendants, who prosecutors said became millionaires while at the firm. Ms. Bongiorno, for example, bought a Bentley and two Mercedes-Benz automobiles as well as a $6.5 million Florida condominium, which she said she purchased to "downsize."

    Continued in article


    From the CFO Journal's Morning Ledger on December 3, 2013

    Madoff’s ex-finance chief takes the stand
    Frank DiPascali, Bernie Madoff’s one-time chief financial officer, told jurors yesterday that the Ponzi scheme stretched back “as far as I can remember,” to his earliest days at the firm as a 19-year-old in the mid-1970s,
    Reuters reports. Mr. DiPascali is the government’s star witness in its case against five former Madoff employees charged with abetting Madoff’s fraud. While defense attorneys are expected to argue he is merely trying to earn a more lenient sentence for himself, Mr. DiPascali’s testimony represents the most detailed depiction to date of daily activity within the now-disgraced investment firm and how it deceived customers and regulators, the WSJ says. He said that, to his knowledge, none of the trades Mr. Madoff’s firm recorded in the accounts for investment customers ever actually took place. Asked if the staff created trades out of thin air, he answered, “Literally, yes.”

    Why Madoff's Hedge Fund Could Be Audited by Non-registered Auditors
    We all know that Bernie Madoff's brokerage firm was audited by an obscure 3-person accounting firm that is not registered with the Public Company Accounting Oversight Board.  This was permitted because the SEC exempted privately owned brokerage firms from the SOX requirement that firms are audited by registered accountants.  Floyd Norris reports, in today's NY Times, that the SEC has now quietly rescinded that exemption.  As a result, firms that audit broker-dealers for fiscal years that end December 2008 or later will have to be registered.  However, under another SOX provision, PCAOB is allowed to inspect only audits of publicly held companies.  NYTimes, Oversight for Auditor of Madoff.
    "Why an Obscure Accounting Firm Could Audit Madoff's Records," Securities Law Professor Blog, January 9, 2008 ---
    http://lawprofessors.typepad.com/securities/

    Teaching Case on Madoff Fraud Deceptions
    From The Wall Street Journal Accounting Weekly Review on December 6, 2013

    Madoff Lieutenant Describes Ploy to Outwit Auditor
    by: James Sterngold
    Dec 04, 2012
    Click here to view the full article on WSJ.com
     

    TOPICS: Auditing, Fraud, Fraud Detection, Fraudulent Financial Reporting, Ponzi Schemes

    SUMMARY: Five accused employees of Bernard L. Madoff's securities firm began the first day of their trial for "...their alleged roles in perpetuating an elaborate scam that lasted more than three decades and stole nearly $20 billion from customers." Frank DiPascal Jr., a former "top lieutenant" to Berard L. Madoff, pleaded guilty shortly after the Ponzi scheme was discovered in December 2008. He is now cooperating with the prosecutors. In court testimony, he described elaborate steps taken, and collusion amongst, himself and the indicted former Madoff employees to hide the fraud from a KPMG auditor.

    CLASSROOM APPLICATION: The article is useful to cover auditors' responsibility to detect fraud. Questions help students to understand the difficulty of detecting fraud in the face of collusion.

    QUESTIONS: 
    1. (Introductory) What is a Ponzi scheme? Describe the length and extent of the Ponzi scheme perpetrated by Bernard Madoff and his investment firm.

    2. (Advanced) Summarize an auditor's responsibility to detect fraud with reference to auditing standards.

    3. (Advanced) What is collusion? How did alleged collusion apparently add to the difficulty of detecting fraud in the case of Bernard L. Madoff's securities firm?

    4. (Introductory) What former members of Bernard L. Madoff 's firm are now beginning trial for their alleged crimes? Summarize the executives' positions based on the descriptions in the article.

    5. (Introductory) What question did an auditor ask of the Madoff firm executive Frank DiPascali?

    6. (Introductory) What does Mr. DiPascali say that he and several other employees did to satisfy the auditor's request?

    7. (Advanced) Given the documentation requested by the auditor, what outside information might have uncovered the fraud committed by Bernard L. Madoff and, allegedly, the former executives and employees facing trial? Specifically describe a piece of evidentiary matter or other auditor responsibility that is recommended in auditing standards which might have helped the KPMG auditor uncover the fraud.
     

    Reviewed By: Judy Beckman, University of Rhode Island

    "Madoff Lieutenant Describes Ploy to Outwit Auditor," by James Sterngold, The Wall Street Journal, December 4, 2013 ---
    http://online.wsj.com/news/articles/SB10001424052702304579404579234593126376328?mod=djem_jiewr_AC_domainid

    A top lieutenant to Bernard L. Madoff explained in detailed, often colorful testimony the lengths required to maintain the firm's massive Ponzi scheme, including one incident in which the staff put fake trading records into a refrigerator so an auditor wouldn't be able to tell they were still warm from having just been printed.

    In his first day on the stand, Frank DiPascali Jr., 57 years old, described that madcap day about two decades ago when an auditor demanded to see daily trading logs.

    The staff frantically fabricated a batch of falsified reports and at one point tossed them around "like a medicine ball" to make them look used and crinkled, he said.

    They also put them in the refrigerator to cool the documents down, adding that the deception worked and Mr. Madoff's Ponzi scheme escaped detection.

    "We all got a big chuckle out of that," Mr. DiPascali said.

    Mr. DiPascali, a high-school-educated official who worked at the firm for more than 30 years, testified at the trial of five other former employees who were indicted for their alleged roles in perpetuating an elaborate scam that lasted more than three decades and stole nearly $20 billion from customers.

    The five are Daniel Bonventre, Annette Bongiorno, JoAnn Crupi, Jerome O'Hara and George Perez. They have all denied the charges.

    Mr. DiPascali turned himself in days after the fraud was uncovered in December 2008 and earlier pleaded guilty to criminal charges. He hasn't yet been sentenced.

    Mr. Madoff is in federal prison serving a 150-year sentence for operating the largest Ponzi scheme in history.

    Mr. DiPascali said he worked closely with the five defendants on trial to produce the fake records.

    While defense attorneys are expected to argue he is merely trying to earn a more lenient sentence for himself, his testimony represents the most detailed depiction to date of daily activity within the now-disgraced investment firm and how it deceived customers and regulators.

    His testimony is expected to last most of the week.

    Mr. DiPascali described a scheme that was at times rudimentary in its execution.

    He said that, to his knowledge, none of the trades Mr. Madoff's firm recorded in the accounts for investment customers ever actually took place, and that a number of staff members spent most of their time producing large volumes of fake documents to convince customers they were earning attractive returns.

    Asked if the staff created trades out of thin air, he answered, "Literally, yes."

    The most anxious moments he described came in the early 1990s when the Securities and Exchange Commission began to investigate an accounting firm, Avellino & Bienes, that collected funds from its customers and invested the money in Mr. Madoff's scheme.

    That firm, which had been affiliated with Mr. Madoff's father-in-law, was going to have to produce trading records from its accounts, and Mr. Madoff was concerned that there were red flags in those records.

    So he ordered that the original set of faked documents be replaced with a whole new set—three years of monthly account records—that eliminated the incriminating entries.

    "They were in essence the wrong faked trades," Mr. DiPascali said.

    For instance, they covered up one transfer that would have shown that Mr. Madoff had numerous such advisory accounts.

    Mr. DiPascali and his colleagues also inserted an entry showing that the Avellino & Bienes account owned $86 million in Treasury securities, so it appeared to hold conservative and safe investments.

    Mr. DiPascali explained the deception and the prosecutor showed handwritten documents allegedly from Ms. Bongiorno ordering those specific changes.

    The incident with the refrigerator started when an auditor from KPMG, the big accounting firm, demanded to see detailed daily trading logs to confirm that the firm was actually engaging in the trading it was documenting on customer account statements.

    The staff had already fabricated such records for one day, in anticipation of such a request, but the auditor asked for the records for a different day, Mr. DiPascali said.

    Mr. DiPascali called one of the firm's computer technicians and pretended to be asking for the records as though they already existed, and sought to distract the auditor.

    Continued in article


    Mary Schapiro --- http://en.wikipedia.org/wiki/Mary_Schapiro

    It (the Report) says Ms. Schapiro agreed with a decision to keep Mr. Becker from testifying before Congress, where he would have disclosed his financial interest in the Madoff account.
    See below

    "S.E.C. Hid Its Lawyer’s Madoff Ties," by Louise Story and Gretchen Morgenson, The New York Times, September 20, 2011 ---
    http://www.nytimes.com/2011/09/21/business/sec-refers-ex-counsels-actions-on-madoff-to-justice-dept.html?_r=1&ref=business

    After Bernard L. Madoff’s giant Ponzi scheme was revealed, the Securities and Exchange Commission went to great lengths to make sure that none of its employees working on the case posed a conflict of interest, barring anyone who had accepted gifts or attended a Madoff wedding.

    But as a new report made clear on Tuesday, one top official received a pass: David M. Becker, the S.E.C.’s general counsel, who went on to recommend how the scheme’s victims would be compensated, despite his family’s $2 million inheritance from a Madoff account.

    Mr. Becker’s actions were referred by H. David Kotz, the inspector general of the S.E.C., to the Justice Department, on the advice of the Office of Government Ethics, which oversees the ethics of the executive branch of government.

    The report by Mr. Kotz provides fresh details about the weakness of the agency’s ethics office and reveals that none of its commissioners, except for Mary L. Schapiro, its chairwoman, had been advised of Mr. Becker’s conflict.

    It says Ms. Schapiro agreed with a decision to keep Mr. Becker from testifying before Congress, where he would have disclosed his financial interest in the Madoff account.

    Mr. Kotz’s inquiry also produced evidence that at least one S.E.C. employee had been barred from working on Madoff-related matters because of a conflict, suggesting there was a double standard at the agency.

    The findings are another black eye for an agency that has tried to be more aggressive in recent years after failing to uncover the Madoff fraud. More recently, the S.E.C. has been criticized for routine destruction of some enforcement documents that might have been useful in later investigations.

    The agency has also been criticized for its slow pace in writing new financial regulations mandated by the Dodd-Frank law and for the dearth of cases brought against individuals at major financial companies that were involved in the mortgage crisis.

    Federal conflict of interest law requires government employees to be disqualified from participating in a matter “if it would have a direct and predictable effect on the employee’s own financial interests.”

    Nevertheless, Mr. Becker “participated personally and substantially in particular matters in which he had a personal financial interest,” Mr. Kotz wrote in his report.

    Though the referral was made to the Justice Department’s criminal division, it could be handled as a civil matter. A Justice Department spokeswoman declined to comment, other than confirming the referral.

    Mr. Becker’s tie to the Madoff situation came from a Madoff account held by his mother, who died in 2004. Her three sons inherited the account and closed it shortly thereafter, with a $1.5 million profit, based on Mr. Madoff’s fraud.

    Mr. Madoff carried out an enormous Ponzi scheme for more than a decade, costing investors more than $20 billion in actual losses. He is now serving a 150-year sentence in a prison in North Carolina.

    Mr. Becker’s lawyer, William R. Baker III, said in a statement that the report confirmed that Mr. Becker had notified seven senior S.E.C. officials about his late mother’s Madoff account, including Ms. Schapiro and the agency’s designated ethics officer.

    “The inspector general concluded that ‘none of these individuals recognized a conflict or took any action to suggest that Becker consider recusing himself from the Madoff liquidation,’ “ wrote Mr. Baker, a lawyer at Latham & Watkins who worked at the S.E.C. for 15 years, working alongside Mr. Becker at times. He said the report contained “a number of critical factual and legal errors,” but declined to enumerate them. Mr. Becker left the S.E.C. last February.

    Continued in article

    "The SEC's Ethics:  Washington's double standard on conflicts of interest," The Wall Street Journal, September 23, 2011 ---
    http://online.wsj.com/article/SB10001424053111903703604576584620319633188.html#mod=djemEditorialPage_t

    Who says partisanship rules Washington? House Republicans showed remarkable forbearance yesterday toward SEC Chairman Mary Schapiro over an ethics flap involving the Bernie Madoff case and conflict-of-interest laws.

    "What is clear about this situation is that you did make a mistake. You admitted such and you said had you known then what you now know, you would have acted differently," Rep. Patrick McHenry (R., N.C.) told Ms. Schapiro at a public hearing. We doubt Ms. Schapiro and her SEC cops would have been so forgiving toward someone in private life who made the same "mistake."

    We're referring to this week's remarkable report from SEC Inspector General David Kotz disclosing how the SEC's former top lawyer, David Becker, directly handled matters relating to the Madoff fraud case despite his mother's $2 million investment with the firm, to which he and his brothers were heirs.

    Mr. Becker's involvement potentially influenced whether investors who got money out of the Madoff operation before it was exposed could be shielded from so-called "clawback" lawsuits brought by those liquidating the Madoff estate. Mr. Kotz says Mr. Becker "participated personally and substantially in particular matters in which he had a personal financial interest" through his inheritance of his mother's estate.

    The conflict here would seem to be obvious, and Mr. Becker did at least disclose it—to Ms. Schapiro shortly after arriving at the SEC in February 2009. "I did precisely what I was supposed to do," he told Congress yesterday. "I identified a matter that required legal advice from the SEC's Ethics Office. I sought that advice, received it and followed it."

    But that still leaves the role played by Ms. Schapiro, who never told her fellow commissioners about the conflict, going so far as to let them vote on how to divide up the Madoff assets, a change from which Mr. Becker stood to benefit. Only in February, after Mr. Becker was named in a clawback lawsuit by Madoff trustee Irving Picard, did the commissioners learn of the conflicts by reading the press.

    Ms. Schapiro declined our request for an explanation this week, but she has said she would have had Mr. Becker recused if she had "understood that he had any financial interest in how this was resolved." But then why did she think he had informed her of his family's Madoff connection? She also said she would have wanted to disclose the Madoff connection if Mr. Becker had testified on the issue "so that we were completely forthcoming with Congress."

    Hmmm. The same IG report also highlights that the SEC decided not to have Mr. Becker testify to Congress on Madoff issues lest his conflict become public. Mr. Becker told the IG under oath that after he mentioned the need to disclose the inheritance up front if he did go before Congress, the SEC's Office of Intergovernmental and Legislative Affairs Director Eric Spitler wrote that "now that I think about it, I think it would be better if someone else testified. My concern is not that there's anything wrong with it," but "when you're in a political environment . . . it would be a distraction."

    Mr. Spitler has said that Ms. Schapiro agreed that Mr. Becker shouldn't appear before Congress, though she says she does not recall how the matter was settled.

    The only word for all of this is astonishing. We don't think all conflicts-of-interest are disqualifying, and they can be managed to avoid trouble. But this one isn't a close call. Imagine how the SEC's enforcement cops would handle a private company that let a general counsel play such a role. For such a conflict to be passed off as inconsequential, and then covered up, by the agency that is supposed to investigate bad financial actors is more than a mistake. It's faulty judgment that suggests an ethical blind spot.

    Continued in article

    Bob Jensen's threads on the Madoff Ponzi Scandal ---
    http://www.trinity.edu/rjensen/FraudRotten.htm#Ponzi

    Jensen Comment
    I just do not have an ounce of respect for any of the previous SEC directors who sold their souls to and integrity to protecting the tycoons by letting them off easy when they stole billions from investors. Mary Schapiro is no exception.

    These two items say a lot (bad) about Mary Shapiro's SEC --- http://en.wikipedia.org/wiki/Mary_Shapiro

    "Clawbacks Without Claws," by Gretchen Morgenson, The New York Times, September 10, 2011 ---
    http://www.nytimes.com/2011/09/11/business/clawbacks-without-claws-in-a-sarbanes-oxley-tool.html?_r=2&emc=tnt&tntemail1=y

    AFTER the grand frauds at Enron, WorldCom and Adelphia, Congress set out to hold executives accountable if their companies cook the books.

    Fair Game Clawbacks Without Claws By GRETCHEN MORGENSON Published: September 10, 2011

    Recommend Twitter Linkedin Sign In to E-Mail Print Single Page Reprints Share

    AFTER the grand frauds at Enron, WorldCom and Adelphia, Congress set out to hold executives accountable if their companies cook the books. Add to Portfolio

    Diebold Inc New Century Financial Corp NutraCea

    Go to your Portfolio »

    Under the Sarbanes-Oxley Act of 2002, the Securities and Exchange Commission was encouraged to hit executives where it hurts — in the wallet — if they certified financial results that turned out to be, in a word, bogus.

    SarbOx was supposed to keep managers honest. They would have to hand back incentive pay like bonuses, even if they didn’t fudge the accounts themselves.

    That, anyway, was the idea. The record suggests a bark decidedly worse than its bite. The S.E.C. brought its first case under Section 304 of SarbOx in 2007. Since then, it has filed cases demanding that only 31 executives at only 20 companies return some pay.

    In 2007 and 2008, most of the cases involved shenanigans with stock options and produced some big recoveries. In the wake of the financial crisis, the dollars recouped have amounted to an asterisk. Since the beginning of 2009, the S.E.C. has pursued 18 executives at 10 companies. So far, it has recovered a total of $12.2 million from nine former executives at five. The other cases are pending.

    “It seems like a dormant enforcement tool,” Jack T. Ciesielski, president of R. G. Associates and editor of The Analyst’s Accounting Observer, says of the SarbOx provision. “It was supposed to be a deterrent, but it’s only really a deterrent if they use it.”

    How assiduously the S.E.C. enforces this aspect of Sarbanes-Oxley is important. Only the S.E.C. can bring cases under Section 304. Companies can’t. Nor, it appears, can shareholders. In 2009, the Court of Appeals for the Ninth Circuit ruled that there was no private cause of action for violations of Section 304.

    Half the companies pursued by the S.E.C. during the past three years have been small and relatively obscure.

    For example, the commission sued executives at SpongeTech Delivery Systems (2008 revenue: $5.6 million), contending that the company had booked $4.6 million in phony sales that year. NutraCea, a maker of dietary supplements with 2008 sales of $35 million, was sued along with Bradley D. Edson, its former chief executive, over what the S.E.C. called its recording of $2.6 million in false revenue. An executive at Isilon Systems, a data storage company, was pursued because, the S.E.C. maintained, the company had inflated sales by $4.8 million during 2007.

    No money has been recovered in the SpongeTech or Isilon matters, which are still pending. Mr. Edson, who could not be reached for comment, returned his 2008 bonus of $350,000.

    In all cases when executives have returned money, they have neither admitted nor denied allegations.

    The S.E.C. typically recovers more money from executives at bigger companies. But top executives are rarely compelled to return all their incentive pay.

    In a case brought last year against Navistar, for example, the S.E.C. contended that the company had overstated its income by $137 million from 2001 through 2005. Daniel C. Ustian, who is Navistar’s chief executive and who was not charged with wrongdoing, returned common stock worth $1.32 million. He had received $2.2 million in incentive pay and restricted stock during the time that the S.E.C. says Navistar inflated its accounting. A company spokeswoman said Mr. Ustian would not comment.

    Robert C. Lannert, Navistar’s former chief financial officer, who also was not charged, gave back stock worth $1.05 million. His incentive pay consisted of only $828,555 during the years that the S.E.C. said the company misstated its results. He didn’t return a phone call seeking comment.

    ANOTHER case brought by the S.E.C. last year involved Diebold, a maker of automated teller machines. Contending that Diebold had overstated its results by $127 million between 2002 and 2007, the commission sued to recover money from three former executives. Walden W. O’Dell, who is a former C.E.O. and who was not charged, repaid $470,000 in cash, and 30,000 Diebold shares and 85,000 stock options. During the years that the S.E.C. alleged that results were overstated, he received bonuses totaling $1.9 million, in addition to restricted stock worth $261,000 and 295,000 stock options. Mr. O’Dell didn’t return a message seeking comment. The cases against the other Diebold executives are pending. A company spokesman said it had settled with regulators and declined to comment further.

    Continued in article

    "Commissioner slams SEC settlement," SmartPros, July 13, 2011 ---
    http://accounting.smartpros.com/x72323.xml

    One of the SEC's five commissioners has taken the extraordinary step of publicly dissenting from an enforcement action on the grounds that it was too weak.

    Commissioner Luis A. Aguilar said the Securities and Exchange Commission should have charged a former Morgan Stanley trader with fraud in view of what he called "the intentional nature of her conduct."

    The dissent comes weeks after the SEC took flak for negotiating a $153.6 million fine from J.P. Morgan Chase in another enforcement case but taking no action against any of the firm's employees or executives.

    Under a settlement announced Tuesday, the SEC alleged that former Morgan Stanley trader Jennifer Kim and a colleague who previously settled with the agency had executed at least 32 sham trades to mask the amount of risk they had been incurring and to get around an internal restriction.

    Their trading contributed to millions of dollars of losses at the investment firm, the SEC said.

    Without admitting or denying the SEC's findings, Kim agreed to pay a fine of $25,000.

    Aguilar said the settlement was "inadequate" and "fails to address what is in my view the intentional nature of her conduct."

    "The settlement should have included charging Kim with violations of the antifraud provisions," Aguilar wrote.

    Continued in article

    Bob Jensen's Fraud Updates --- http://www.trinity.edu/rjensen/FraudUpdates.htm

    Bob Jensen's threads on the Madoff Ponzi Scandal ---
    http://www.trinity.edu/rjensen/FraudRotten.htm#Ponzi


    Madoff Book's 9 Juiciest Bits --- Click Here
    http://www.thedailybeast.com/articles/2011/10/21/bernie-madoffs-daughter-in-law-on-husbands-suicide-and-bernies-crime.html

    The End of Normal, by Stephanie Madoff Mack. Blue Rider Press. 253 p. $17.43 (prices may vary)


    "Accountant Linked to Madoff Is Indicted," by Reed Albergotti, The Wall Street Journal, September 27, 2013 ---
    http://online.wsj.com/article/SB10001424052702304526204579099193990812048.html?mod=djem_jiewr_AC_domainid

    Paul Konigsberg, a long-time former accountant to Bernard Madoff, was indicted Thursday for allegedly keeping false books that helped the convicted Ponzi-scheme operator cover up the fraud for decades.

    Mr. Konigsberg, 77 years old, was arrested at 6 a.m. by agents from the Federal Bureau of Investigation, nearly five years after the Madoff Ponzi scheme was first discovered. Mr. Konigsberg pleaded not guilty and was released on bail Thursday.

    Mr. Konigsberg's attorney, Reed Brodsky, said his client "is an innocent victim of Bernie Madoff."

    "He looks forward to clearing his good name at trial," Mr. Brodsky said. "In their witch hunt arising out of the largest Ponzi scheme in history, the government conveniently ignores that the sociopath Bernie Madoff deceived everyone around him—from the most sophisticated investors to the SEC itself."

    In a five-count criminal indictment, prosecutors accused Mr. Konigsberg of conspiracy and of falsifying records. They didn't accuse him of having knowledge of Mr. Madoff's Ponzi scheme.

    "In order to keep his scheme hidden for so long, Madoff needed the assistance of certain willing outsiders that could be trusted to handle otherwise suspicious activity," the indictment said.

    "In particular, Madoff directed many of his clients—including some of his most important customers, in whose accounts Madoff executed the most glaringly fraudulent transactions—to use Paul J. Konigsberg, the defendant, as their accountant."

    The charges come just weeks before a criminal trial of five former Madoff employees is slated to begin. Five back-office employees, including two computer programmers and a secretary, are accused of a host of crimes, including conspiracy, securities fraud and falsifying records. The former employees have denied wrongdoing

    According to a person briefed on the investigation, prosecutors believe they have less than a year to bring cases against people they suspect of having played a role in the Ponzi scheme, given the five-year statute of limitations on securities-fraud cases.

    Mr. Madoff, 75 years old, admitted in March 2009 that he carried out a decades-long Ponzi scheme, and is serving a 150-year sentence in federal prison in North Carolina. He has always insisted he acted alone.

    So far, prosecutors have focused their investigation on easier-to-prove charges like making false statements to investors and government agencies. Nine people, including Mr. Madoff, have pleaded guilty to criminal charges in connection with the probe but none other than Mr. Madoff have admitted to knowing about the fraud. Last year, Mr. Madoff's brother, Peter, pleaded guilty to filing false documents as chief compliance officer at the firm, but denied knowing about the Ponzi scheme. He was sentenced to 10 years in prison.

    Mr. Konigsberg, a partner at accounting firm Konigsberg Wolf & Co., is the second former accountant to come under scrutiny in the criminal investigation. David Friehling, Mr. Madoff's former outside accountant, has previously pleaded guilty to criminal charges.

    According to a person familiar with the matter, federal criminal investigators also are looking into whether J.P. Morgan Chase JPM -0.29% & Co. or its employees funneled money into the Madoff scheme while ignoring warning signs about the fraud. J.P. Morgan didn't respond to a request for comment.

    J.P. Morgan is one of a number of banks that faced civil lawsuits in recent years filed by court-appointed trustee Irving Picard, who is tasked with recovering funds for victims. Mr. Picard's lawsuit alleges that J.P. Morgan was "at the very center" of Mr. Madoff's fraud, and "thoroughly complicit in it."

    However, in June, 2013, Mr. Picard's lawsuit against J.P. Morgan and other banks was blocked from going forward because an appeals court ruled that the lawsuit didn't comply with bankruptcy laws. The appeals court didn't address the validity of Mr. Picard's allegations against J.P. Morgan and other banks. Mr. Picard is weighing his options.

    Last year, investigators focused on Shana Madoff, Peter Madoff's daughter, who served as in-house counsel and compliance director. It is unclear whether prosecutors are considering any action against her. She hasn't been accused of wrongdoing. A lawyer for Shana Madoff said he is no longer representing her. She couldn't be reached for comment.

    Prosecutors also continue to investigate Andrew Madoff, Bernie Madoff's son, according to people familiar with the matter. A lawyer for Andrew Madoff didn't respond to a request for comment.

    The coming trial of the five ex-employees could offer further insight into Mr. Madoff's operation, which went undetected for decades by regulators and investors. At a pretrial hearing on Wednesday, prosecutors were told by the judge that they couldn't introduce evidence of the defendants' lavish lifestyle while employed with Mr. Madoff, including purchases of expensive cars and vacation homes, lest that unfairly colors jurors' perceptions. However, prosecutors would be allowed to share evidence of other purchases funded directly by the Madoff enterprise, including a Caribbean vacation.

    Continued in article

     


    A Starr for the Stars Fell Into a Prison Yard

    "Financial Adviser to Stars Pleads Guilty to Fraud," by Julie Creswell and Colin Moynihan, The New York Times, September 10, 2010 ---
    http://www.nytimes.com/2010/09/11/business/11fraud.html?_r=2&dbk

    Kenneth I. Starr, the New York investment adviser who once counted Hollywood celebrities like Al Pacino, Martin Scorsese and Sylvester Stallone as clients, pleaded guilty on Friday in Federal District Court in Manhattan to charges that he diverted tens of millions of dollars of his clients’ money to pay for his lavish lifestyle.

    A money manager to the stars who frequented charity events, high-profile parties and movie premieres in search of clients, Mr. Starr, 66, wore a dark blue prison smock and appeared stooped and drawn as he stood before Federal Magistrate Judge Theodore H. Katz and pleaded guilty to one count each of wire fraud, money laundering and investment adviser fraud.

    Mr. Starr, who is not related to the special prosecutor with the same name who investigated President Bill Clinton, admitted that he stole $20 million to $50 million from his clients to use for his own purposes.

    Some of the money paid a multimillion-dollar legal settlement with a former client while other money bought a sprawling $7.5 million Upper East Side condo complete with a lap pool and a 1,500 square-foot garden.

    A plea agreement between Mr. Starr and the government calls for a prison sentence of 10 to 12.5 years. But Federal District Judge Shira A. Scheindlin, who is scheduled to sentence Mr. Starr on Dec. 15, is not bound by that agreement and could impose a greater or lesser penalty.

    The government said it could also seek the forfeiture of as much as $50 million in assets owned or controlled by Mr. Starr and $50 million in restitution for his victims.

    After the courtroom proceedings, a lawyer for Mr. Starr, Flora Edwards, indicated that the forfeiture and restitution amounts were under discussion but that they were likely to be “significantly less” than $50 million.

    “He’s assumed full responsibility for his conduct,” Ms. Edwards said. “He made a colossal error in judgment that he recognizes. He’s paying a very, very heavy price.”

    In a statement, Preet Bharara, the United States attorney in Manhattan, said, “Kenneth Starr’s is a tale of fiction and fraud, in which he played the role of legitimate investment adviser to a cast of unsuspecting victims.”

    Mr. Starr was indicted in June on 23 counts, including wire fraud, securities fraud, fraud by an investment adviser and money laundering.

    Clients relied on him to provide investment advice, financial planning and even pay bills and help with tax filings, federal prosecutors said in the indictment.

    In federal court on Friday, Mr. Starr admitted that his clients had “entrusted him” with their money, but that “from 2009 to 2010, instead of using my clients’ money as I promised, I knowingly used a portion of the money for my own purposes,” he told the judge.

    Continued in article

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


    From Paul Caron on May 10, 2011 --- http://taxprof.typepad.com/

    Morgan: International Tax Law as a Ponzi Scheme

    Ed Morgan (University of Toronto, Faculty of Law) has posted International Tax Law as a Ponzi Scheme, 34 Suffolk Transnat'l L. Rev. ___ (2011), on SSRN. Here is the abstract:

    This paper explores the extent to which international tax law is more than the sum of its parts. It does so by examining three recent legal/policy decisions. The 2006 judgement of the Tax Court of Canada in MIL Investments decided that a statutory general anti-avoidance rule of interpretation does not operate to bar the practice of treaty shopping for corporate residence; the 2008 judgement of the United States Tax Court in Jameison determined that the alternative minimum tax credit limitation trumps the Canada-United States tax treaty foreign tax credit as the last-in-time enactment; and the Internationally Agreed Tax Standards issued by the OECD seek to implement a coordinated international standard for tax reporting. These decisions demonstrate that although tax treaty networks and a centralized OECD structure have been put in place, the interpretation and application of these instruments reflect much international law thinking in that they invariably circle back to unilateral state policy.

    Bob Jensen's threads on Ponzi Schems --- http://www.trinity.edu/rjensen/FraudRotten.htm#Ponzi


    Bernard Madoff --- http://en.wikipedia.org/wiki/Madoff

    Infographic:  The Fraud of Bernie Madoff --- http://www.usfst.com/The-Fraud-of-Bernard-Madoff.html
    Thank you Nadine Sabai for the heads up.

    Hi Ron,

    You can read more about Friehling at
    http://en.wikipedia.org/wiki/David_G._Friehling#Arrest_and_plea

    He was never licensed as an auditor and lost his CPA certificate after pleading guilty ---
    http://www.taxgirl.com/friehling-loses-cpa-license-still-awaits-sentencing/

    His sentencing kept getting postponed  ---
    http://www.nysscpa.org/blog/2010/9/2/madoff-auditor-sentencing-postponed-until-march

    Madofff of course got 150 years and seems to be totally unrepentant. Some criminals just seem to be born without consciences and are incapable of remorse. Of course he's in a comfortable Club Fed where he purportedly somewhat enjoys prison life and sees his loyal wife quite often. I wish he had been sent to a NY state prison like Attica ---
    http://en.wikipedia.org/wiki/Attica_Correctional_Facility
    Life would not be so cushy in Club Attica.

    You can read quite a lot about Bernie at
    http://en.wikipedia.org/wiki/Madoff


    Madoff was a prominent philanthropist, but this was largely a ruse to get other rich people to invest in his Ponzi hedge fund. As far as I can tell there's not one thing good about Bernie Madoff that offsets his scheming evil. Well yes, there is one good thing. The evidence against him was so overwhelming that at least he did not prolong his punishment for years in court with the highest priced lawyers in the State of New York. Some of those lawyers could've tied up the case of Attilla the Hun for ten years or more.

    My threads on Bernie are at http://www.trinity.edu/rjensen/FraudRotten.htm#Ponzi
    Bob Jensen

    Update
    "Madoff Accountant Avoids Prison Term," by Matthew Goldstein, The New York Times, May 28, 2015 ---
    http://www.nytimes.com/2015/05/29/business/dealbook/madoff-accountant-avoids-prison-term.html?emc=edit_tnt_20150528&nlid=27162368&tntemail0=y&_r=0 

    By his own admission, David G. Friehling was not much of an auditor for Bernard L. Madoff — pretty much rubber-stamping financial statements for the man who masterminded an enormous Ponzi scheme.

    As a cooperating witness, however, Mr. Friehling won plaudits from federal prosecutors, and because of that he will not serve any time in prison for his role in the financial fraud, which lasted more than two decades.

    A federal judge on Thursday sentenced Mr. Friehling, 55, to a year of home detention and another year of supervised release. Judge Laura Taylor Swain of Federal District Court in Manhattan noted that Mr. Friehling had cooperated extensively with federal prosecutors, including testifying for several days during a lengthy trial last year that resulted in the convictions of five former employees of Mr. Madoff’s securities firm. Continue reading the main story Related Coverage

    Frank DiPascali Jr. in Manhattan Federal Court on Monday, December 2, 2013. Bernie Madoff’s Essential ManMAY 15, 2015 Frank DiPascali Jr. faced a prison term of up to 125 years. Frank DiPascali Jr., Madoff Aide Who Pleaded Guilty in Fraud, Dies at 58MAY 10, 2015

    Mr. Friehling could have been sentenced to more than 100 years in prison for his part in the Ponzi scheme that authorities estimate caused investors to lose $17.5 billion in principal and tens of billions more in paper wealth.

    To some degree, ignorance worked in Mr. Friehling’s favor when it came to sentencing.

    Federal prosecutors, in arguing for a lenient sentence for Mr. Friehling, who also served as a personal accountant for Mr. Madoff and his sons, said he had been unaware of the full extent of Mr. Madoff’s long-running scheme. But that was only because Mr. Friehling had “abdicated” his responsibilities as the firm’s auditor and approved the financial statements Mr. Madoff gave him without asking any questions.

    “His crime came down to his failure to do his job,” said Randall W. Jackson, an assistant federal prosecutor under Preet Bharara, the United States attorney for Manhattan.

    Continued in article

    Fraud Updates
    http://www.trinity.edu/rjensen/FraudUpdates.htm


    You can play amateur psychologist with new revelations from Bernie Madoff behind bars

    "From behind bars, Madoff spins his story,"  by David Gelles and Gillian Tett, Financial Times, April 8, 2011 ---
    http://www.ft.com/cms/s/2/a29d2b4a-60b7-11e0-a182-00144feab49a.html?ftcamp=traffic/email/regsnl//memmkt/#axzz1JVhNNEee 

    We are cruising through North Carolina on a foggy morning in late March, heading up to its rural north. Our route takes us through swampland shrouded in a thick mist; spruce trees and an occasional pink dogwood line the interstate. Butner, population 6,391, is our destination.

    The town is home to a vast federal prison complex that includes a hospital, a minimum security unit and two medium security facilities. Since July 14 2009, arguably the most notorious inmate at FCI Butner Medium I has been Bernard Lawrence Madoff, the disgraced New York financier who orchestrated a $65bn Ponzi scheme, among the biggest financial frauds of all time. He is prisoner 61727-054.

    When the Madoff scandal broke in 2008, a Financial Times reporter learnt that two acquaintances of his were close to the Madoffs and passed along an invitation for any member of the family to speak with the paper. For more than a year, there was silence. Then, early last December, the reporter received an e-mail from Madoff himself. Following sporadic correspondence, and at very short notice, a message came from the prison: Madoff would meet with the FT.

     It is only the second time he has agreed to meet a reporter in prison. But as we drive north, we wonder if this man who built his career on lies will tell us the truth. Or when we get to the prison, will he simply vanish – like all those billions in his Ponzi scheme? Crossing rusted train tracks, we drive a couple of miles and arrive at the main intersection of this one-traffic-light town.

    Butner revolves around the prison. Its centre is just a clutch of convenience stores and a petrol station. In search of strong coffee we consult an iPhone: the nearest Starbucks is 18.4 miles away. Instead, we go to a diner and order the classic southern fare of biscuits and grits. The coffee is terrible.

    . . .

    Exactly when the Ponzi scheme started is actually a matter of dispute. The trustee seeking to retrieve assets for Madoff’s victims, Irving Picard, says the fraud began as early as 1983. But Madoff denies this, telling us that in the 1980s, at least, he was making plenty of legitimate trades. “[The prosecutors] came up with this idea that I came up with this whole legitimate business to come up with this fraud,” he says. “That is wrong. In the end I left $1bn on the table. I had access to any Swiss bank and offshore bank in the world if I had wanted to stash money. But it wasn’t about the money.”

    To hear Madoff say it was not about the money strikes us as improbable. He spent lavishly on his lifestyle; after the fraud was revealed, authorities uncovered $75m in a Gibraltar bank account and millions in jewelry and luxury goods. These were reminders of how much Madoff personally had to lose. He was on the board of Yeshiva University and a regular at charity balls in Manhattan. He and Ruth holidayed in Monte Carlo, where she liked to shop.

    We ask why he didn’t just hand the money back to investors. After all, he says that in 1992 he was already a fairly wealthy man, since the market-making operation was performing well. “Ego,” he explains. “Put yourself in my place. Your whole career you are outside the ‘club’ but then suddenly you have all the big banks – Deutsche Bank, Credit Suisse – all their chairmen, knocking on your door and asking, ‘Can you do this for me?’

    “[I was] under a lot of pressure – a lot,” he mutters. “And I was embarrassed. It was the first time in my life that something hadn’t worked. I was just dumb. Dumb! Starting in the early 1990s there were no trades. It was just paper. But let me tell you,” he adds forcefully. “It looked real.”

    Once the Ponzi scheme was under way, it required a constant influx of new cash. Madoff began taking on clients referred to him by existing ones, who were inclined to keep their money parked with him because of the steady returns. At some point – Madoff never makes it clear exactly when – the real trading ceased altogether, and he began forging trade records for clients. And he says Picower, Chais, Levy and Shapiro – his big four clients – knew something was amiss. “They were complicit, all of them,” he says.

    Madoff’s accusations cannot be corroborated. None of the four families has been charged with criminal wrongdoing. Picower is dead, and his estate settled for $7.2bn; his lawyers maintain he was not aware of the fraud. Levy is dead and his family settled for $220m. Chais is dead; his family denies any wrongdoing and has not settled. And Shapiro, the only one still alive, settled for $625m but denies any wrongdoing and has not been accused by authorities of being complicit. In the words of his lawyer, “Mr Madoff is a liar. These latest statements are no more believable than all the other lies that Madoff told his investors and the authorities for decades.”

    On its surface, the fraud looked real enough to attract a steady stream of new investors, and not just from the US. According to Madoff, there were rich clients on both sides of the Atlantic eager to use his services to dodge local regulations. In France, for example, wealthy clients initially invested with him in order to avoid rules that prevented them from exporting francs.

    “I did it for all of them – so many important people from France and elsewhere,” says Madoff. “That woman from L’Oréal, Christian Dior, so many – I even impressed myself. They came up to my office to meet me. They really wanted to deal with me.” The woman from L’Oréal Madoff refers to is Liliane Bettencourt, one of Europe’s richest women.

    The returns on Madoff’s funds were not extraordinarily high, running at about 10 per cent; however, they were steady, which appealed to conservative European investors. Clients were also reassured by the apparently close ties that Madoff enjoyed to respected French and Swiss banks, such as Union Bancaire Privée.

    Not everybody in Europe was keen to deal with the fund: Société Générale, for example, stayed away. But most investors seemed impressed by Madoff’s “black box”. Some also suspected that Madoff might be using inside information to give him an “edge”. That added to his allure. “The Swiss thought this – they are the most suspicious of all,” Madoff says, revealing a dislike that may stem from his Jewish heritage and the actions of some Swiss banks in relation to Nazi Germany. “Slimy people.”

    In the US, Madoff used his powerful network of contacts across the wealthy Jewish community to lure money. By this time, Madoff had moved into the very heart of the financial “club” he once scorned. He was appointed the chairman of the Nasdaq index, to the board of the Depository Trust & Clearing Corporation, and was vice-chairman of the NASD, his industry’s self-regulatory body.

    This did not prevent the regulators from watching him. “In 2002 I had a contact with the SEC, who were concerned that I was front-running,” he recalls, referring to the practice of using insider information to inform trades. “I started laughing to myself – I knew I wasn’t because I wasn’t doing the trades.” Some of his rivals also asked why his returns were so steady. Harry Markopolos, a fund manager, was so suspicious that he filed reports to the SEC in 2000, and again in 2005, suggesting that Madoff was running a Ponzi scheme. “Markopolos was the biggest idiot in the world,” recalls Madoff, displaying his first flash of anger, blinking hard again. “He had a hedge fund that couldn’t make money and his clients abandoned him [so he called the regulators].”

    But the regulators did not crack down. “The regulators get calls all the time,” Madoff says. They didn’t investigate “because I had the reputation at the time for being the gold standard. I had all the credibility. Nobody could believe at that time that I would do something like that. Why would I? Stupidity – that is why. But remember that when people asked me about the strategy, it made sense. I was big, credible.”

    . . .

    As we leave the prison, we are still not sure where the truth ends and his lies begin. What we know is that this is a man who mercilessly ran a Ponzi scheme for at least 16 years, corrupted the financial system, destroyed lives and bankrupted families and charities. Yet, in the flesh, Madoff spins a credible tale of how a renegade entrepreneur ­conquered Wall Street and was drawn into crime by personalities and forces he could not control. It sounds almost convincing; or at least no more absurd than many of the other stories we hear every day in western finance.

    The fact that so much of Madoff’s story is so commonplace on Wall Street – the tax shelters, black boxes and mysterious returns – is what allowed him to go undetected for so long. And this is why Madoff has sent chills through investors at every level. If the most sophisticated minds in finance were easily duped through an elementary scheme run by one of their own, how can anyone with money invested in the modern financial system know who to trust? This bedevilling question is why Madoff cannot be ignored, even as he ­languishes in a North Carolina prison.

    David Gelles is US media and marketing correspondent. Gillian Tett is the FT’s US managing editor. For expanded coverage and full statements from JPMorgan, UBS, HSBC and Madoff’s prominent clients,
    go to www.ft.com/madoff

    Madoff's Life in Prison ---
    http://www.24x7updates.com/content/20110411/bernard-madoff-interested-teaching-business-ethics-prison-110471.html


    -----Original Message-----
    From: Dennis Beresford [mailto:dberesfo@terry.uga.edu]
    Sent: Monday, March 01, 2010 7:39 AM
    To: Jensen, Robert
    Subject: New book from the man who should have discovered Madoff

    Bob,

    See the NY Times article about Harry Markopolos -

    http://www.nytimes.com/2010/02/28/magazine/28fob-q4-t.html?ref=business

    His book "No One Would Listen" about trying to blow the whistle on  Madoff was published yesterday and is available on Amazon and  elsewhere.  It should be an interesting read.

    Denny


    Infographic:  The Fraud of Bernie Madoff --- http://www.usfst.com/The-Fraud-of-Bernard-Madoff.html
    Thank you Nadine Sabai for the heads up.

    Bob Jensen's threads on the Madoff Ponzi scheme ---
    http://www.trinity.edu/rjensen/FraudRotten.htm#Ponzi

    Fraud Updates
    http://www.trinity.edu/rjensen/FraudUpdates.htm


    Taking an Overdose of Sleeping Pills and Then Being Happy About Waking Up
    CBS 60 Minutes on October 30, 2011

    Watch the Video
    "Ruth Madoff: 'We decided to kill ourselves'," The Washington Post, October 26, 2011 --- Click Here
    http://www.washingtonpost.com/national/ruth-madoff-we-decided-to-kill-ourselves/2011/10/26/gIQARLoAKM_video.html?tid=sm_twitter_washingtonpost

    Bob Jensen's threads on the Ponzi King Bernie Madoff ---
    http://www.trinity.edu/rjensen/FraudRotten.htm#Ponzi

     


    HSBC --- http://en.wikipedia.org/wiki/HSBC

    Jensen Question
    Did KPMG shift its entire Fannie Mae auditing team to HSBC?

    Question
    What was the largest audit client lost by KPMG in the USA?

    Answer
    I did not research this, but the leading contender has to be when KPMG was fired from the Fannie Mae scandal in what was one of the largest earnings management frauds in history coupled with incompetent auditing of financial derivative financial instruments ---
    http://www.trinity.edu/rjensen/Theory02.htm#Manipulation

    From the CFO.com Morning Ledger on March 7, 2013

    KPMG audit contract with HSBC at risk. KPMG could lose the biggest audit contract in Britain after HSBC decided to consider bringing in a fresh pair of eyes to vet its accounts, the FT reports. The bank said it would put its audit contract out to tender for the first time in more than two decades in the most striking sign yet that regulatory pressure is starting to break down the ties that bind many big companies to their auditor. The tender could give KPMG rival Ernst & Young an opportunity to pick up a big British bank as an audit client. HSBC said it wanted the winner of the tender to be in place by 2015.

    "Gangster Bankers: Too Big to Jail:  How HSBC hooked up with drug traffickers and terrorists. And got away with it," by Matt Taibbi, Rolling Stone, February 14, 2013 ---
    http://www.rollingstone.com/politics/news/gangster-bankers-too-big-to-jail-20130214

    PBS Frontline:  Why don't some of biggest fraudsters in history go to prison?
    "The Untouchables," Frontline, January 22, 2013 ---
    http://www.pbs.org/wgbh/pages/frontline/untouchables/?elq=923e1cf54bd4465092ea4b303aac1291&elqCampaignId=511

    March 4, 2013 message from Roger Collins

    From

    http://www.bbc.co.uk/news/business-21653131 

    Some quotes

    "HSBC paid out $4.2bn (£2.8bn) last year to cover the cost of past wrongdoing. As well as $1.9bn in fines for money laundering, the bank also set aside another $2.3bn for mis-selling financial products in the UK. The figures came as HSBC reported rising underlying profitability and revenue in 2012, and an overall profit before tax of $20.6bn

    Chief executive Stuart Gulliver's total remuneration for 2012 was some $7m, compared with $6.7m the year before. And after taking account of the deferral of pay this year and in more highly-remunerated years previously, Mr Gulliver actually received $14.1m in 2012, up from $10.6m in 2011.

    The company's 16 top executives received an average of $4.9m each."

    "During a conference call to present the results, Mr Gulliver told investors that the bank was not reconsidering whether to relocate its headquarters from London back to Hong Kong, in order to avoid a recently agreed worldwide cap on bonuses of all employees of banks based in the EU."

    "HSBC's underlying profits - which ignore one-time accounting effects as well as the impact of changes in the bank's creditworthiness - rose 18%."

    "The bank's results were heavily affected by a negative "fair value adjustment" to its own debt of $5.2bn in 2012, compared with a positive adjustment of $3.9bn the year before. The adjustment is an accounting requirement that takes account of the price at which HSBC could buy back its own debts from the markets. It has the perverse effect of flattering a bank's profits at a time when markets are more worried about its ability to repay its debts, and vice versa."

    More in article.

    Regards,
    Roger Roger Collins
    Associate Professor
    OM1275 TRU School of Business & Economics

    Jensen Question
    Did KPMG shift its entire Fannie Mae auditing team to HSBC?

     


    Note that fraud "risk" warnings are not the same as fraud warnings. It's a little like a local broadcast of a tornado watch versus a tornado warning. A tornado warning reflects an actual tornado is nearby whereas a tornado watch merely states that conditions are ripe for the formation of a tornado that might or might not actually be formed --- http://en.wikipedia.org/wiki/Tornado_Watch

    There's an old saying that the Wizard's magic ball predicted every earthquake in Japan in the past 100 years. But then the Wizard's ball predicts an earthquake for each of 365 days of every year for earthquake-prone Japan.

    "HSBC Was Warned About Madoff ‘Fraud Risks’ in 2006 and 2008 KPMG Reports" Bloomberg, March 18, 2011 ---
    http://www.bloomberg.com/news/2011-03-18/hsbc-was-told-about-bernard-madoff-fund-fraud-risks-in-two-kpmg-reports.html

    HSBC Holdings Plc (HSBA), Europe’s biggest lender, was warned twice by auditors that entrusting as much as $8 billion in client funds to Bernard Madoff opened it up to “fraud and operational risks.”

    KPMG LLP told the London-based bank about the risks in 2006 and 2008 reports. The firm was hired to review how Madoff invested and accounted for the funds, for which HSBC served as custodian. KPMG reported 25 such risks in 2006, and in 2008 found 28, according to copies of the reports obtained by Bloomberg News, which was allowed access to them on the condition they not be published.

    Twenty-five “fraud and related operational risks were identified throughout the process whereby Madoff LLC receive, check and account for client funds,” KPMG said in the 56-page report dated Feb. 16, 2006. The limited controls in place “may not prevent fraud or error occurring on client accounts if management or staff at Madoff LLC either override controls or undertake activities where appropriate controls are not in place,” according to the report.

    A 66-page KPMG report dated Sept. 8, 2008, cited 28 risks and described them in the same words as the 2006 document.

    Irving H. Picard, the trustee liquidating Bernard L. Madoff Investment Securities LLC, sued HSBC and a dozen feeder funds for $9 billion in December in U.S. Bankruptcy Court in Manhattan. The suit was partly based on the KPMG reports and alleges the bank knew of concerns Madoff’s business was a fraud and didn’t protect investors. KPMG’s reports haven’t been made public. Picard has filed more than $50 billion in so-called clawback suits to compensate victims. Reviews ‘Foiled’

    In the reports, KPMG didn’t present evidence the risks it identified had materialized or that it found signs of actual fraud, and said HSBC had told the firm “no allegations of fraud or misconduct have been raised.”

    HSBC confirmed hiring KPMG in 2005 and 2008 to review Madoff’s firm, adding it now believed Madoff had tricked the auditors. “It appears from U.S. government filings that Madoff and his employees foiled these reviews by, among other things, providing forged documentation to KPMG,” the bank said in an e- mailed statement.

    “KPMG did not conclude in either of its reports that a fraud was being committed by Madoff,” HSBC said. “HSBC did not know that a fraud was being committed and lost $1 billion of its own assets as a victim.”

    HSBC Spokesman Patrick Humphris, KPMG spokesman Mark Hamilton and Amanda Remus, a spokeswoman for Picard’s lawyers Baker & Hostetler LLP, all declined to confirm the authenticity of the reports obtained by Bloomberg. Custodian

    At the time of the first report, HSBC was custodian for eight funds that had invested $2 billion with Madoff, KPMG said. By 2008, the bank was custodian for 12 funds with as much as $8 billion invested.

    “We continue to believe that we have strong defenses to the claims made against us and we will defend ourselves,” the London-based bank added.

    Continued in article


    I'm sorry David Friehling, when you say you were duped I don't believe a single word of your plea for leniency!
    Madoff's CPA only pleads guilty to one (wink, wink) professional failure apart from the crimes to which he confessed.
    He should get 150 years in the same cell as Bernie.

    From The Wall Street Journal Accounting Weekly Review on November 5, 2009

    Madoff Auditor Says He Was Duped, Too
    by Chad Bray
    Nov 04, 2009
    Click here to view the full article on WSJ.com

    TOPICS: Audit Quality, Auditing, Auditing Services, Auditor Independence, Fraudulent Financial Reporting

    SUMMARY: David Friehling, former accountant for the Bernard L. Madoff Investment Securities, LLC, pleaded guilty to fraud and other charges in connection with his auditing work for the firm of convicted swindler Bernard Madoff.

    CLASSROOM APPLICATION: The article can be used in an auditing class to cover topics of collecting sufficient competent evidential matter, auditor responsibilities for detecting fraud, business risk associated with taking on personal tax work associated with corporate clients, and overall ethical conduct of an accounting practice.

    QUESTIONS: 
    1. (Introductory) According to the article, what work did Mr. Friehling do for Bernard L. Madoff Investment Securities LLC and for people related to those businesses? List all work that you see identified in the article.

    2. (Introductory) Of what professional failure did Mr. Friehling plead guilty at a hearing before U.S. District Judge in Manhattan?

    3. (Advanced) Mr. Friehling states that he "took the information given to him by Mr. Madoff or Mr. Madoff's employees at 'face value.'" How does that statement imply a failure to conduct adequate audit procedures?

    4. (Advanced) Is it evident from the results of the Madoff fraud case that the firm's auditors must have been guilty of some audit failure? In your answer, comment on an auditor's responsibility to detect fraud and on the likelihood of detecting fraud in cases of collusion.

    5. (Introductory) How is the tax work done by Mr. Friehling for persons related to the Madoff firm resulting in even greater violations of the law and ethical conduct of his practice?

    6. (Advanced) Refer to the second related article. Is it a "GAAP rule" that prevents an auditor or accountant from "just accepting what a client tells you about his financial statements, without doing more..."?

    Reviewed By: Judy Beckman, University of Rhode Island

    RELATED ARTICLES: 
    Bernie Madoff's Small-Town CPA
    by Thomas Coyle
    Nov 04, 2009
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    Is Friehling's Guilty Plea A Warning Shot to Madoff's Family?
    by Ashby Jones
    Nov 04, 2009
    Online Exclusive

    "Madoff Auditor Says He Was Duped, Too:   Friehling Pleads Guilty, but Denies Knowing About the Scheme; 'Biggest Mistake of My Life'," by Chad Bray, The Wall Street Journal, November 4, 2009 ---
    http://online.wsj.com/article/SB125725853747925287.html?mod=djem_jiewr_AC

    David Friehling, the former accountant to convicted Ponzi-scheme operator Bernard Madoff, pleaded guilty to fraud and other charges Tuesday in connection with his auditing work for Madoff's firm, but denied knowing about the underlying Ponzi scheme.

    Mr. Friehling pleaded guilty to securities fraud, aiding or abetting investment advisor fraud, three counts of obstructing or impeding the administration of Internal Revenue laws, and four counts of making false filings with the Securities and Exchange Commission at a hearing before U.S. District Judge Alvin K. Hellerstein in Manhattan.

    Mr. Friehling, 49 years old, admitted that he failed to conduct independent audits of Bernard L. Madoff Investment Securities LLC's financial statements, saying he took the information given to him by Mr. Madoff or Madoff's employees at "face value."

    However, he denied any knowledge of Mr. Madoff's Ponzi scheme and said he entrusted his own retirement and his family's investments to Mr. Madoff, saying he had about $500,000 with the firm.

    In what was "the biggest mistake of my life, I placed my trust in Bernard Madoff," Mr. Friehling said.

    Mr. Friehling, who is cooperating with prosecutors, faces a statutory maximum of 114 years in prison on the charges.

    He was previously charged in the matter in March. Mr. Friehling will be allowed to remain free on $2.5 million bail pending sentencing, which is tentatively set for February.

    Separately, Mr. Friehling, without admitting or denying wrongdoing, agreed to a partial settlement in the SEC's separate civil case. Mr. Friehling, sole practitioner at Friehling & Horowitz CPAs PC, agreed to a permanent injunction restraining him or his accounting firm from violating securities laws.

    Disgorgement, prejudgment interest and civil penalties will be determined at a later date. Mr. Friehling and his firm will be precluded from arguing that they didn't violate federal securities laws as alleged by the SEC for the purposes of determining disgorgement and any penalties.

    Prosecutors from the U.S. Attorney's office in Manhattan alleged that Mr. Friehling, from 1991 to 2008, created false and fraudulent certified financial statements for Madoff's firm.

    Mr. Friehling, who is married and has three children, said Tuesday that he was introduced to Mr. Madoff by Mr. Friehling's father-in-law, Jerome Horowitz.

    Mr. Friehling, a certified public accountant, said Mr. Horowitz retired in 1991 but continued to assist him with Madoff's audits until 1998. Mr. Horowitz, who served as Madoff's auditor until the 1990s, died in March.

    Prosecutors also alleged that Mr. Friehling failed to conduct independent audits of Madoff's firm that complied with generally accepted auditing standards and conformed with generally accepted accounting principles, and falsely certified that he had done so.

    At the hearing, Assistant U.S. Attorney Lisa Baroni said Mr. Friehling prepared false tax returns for Mr. Madoff and others, but declined to say who those others are. "Just 'others' at this time," Ms. Baroni said.

    The court-appointed trustee in charge of liquidating Madoff's firm said recently that he had identified $21.2 billion in cash investor losses.

    Mr. Friehling is the third person to plead guilty to criminal charges in the case, including Mr. Madoff himself.

    Mr. Madoff, 71, admitted in March to running a decades-long Ponzi scheme that bilked thousands of investors out of billions of dollars and is serving a 150-year sentence in a federal prison in North Carolina.

    Frank DiPascali Jr., a key lieutenant to Mr. Madoff, pleaded guilty to criminal charges in August. Mr. DiPascali, who also is cooperating with prosecutors, has been jailed pending sentencing.

    Mr. Madoff ran the scam for years through the investment advisory arm of his business by promising steady returns and by presenting an air of exclusivity by not taking all comers and recruiting investors via friends and associates.

    Mr. Madoff claimed to have as much as $65 billion in his firm's accounts at the end of last November, but prosecutors said the accounts only held a small fraction of that.

    Bob Jensen's threads on index and mutual fund frauds are at
    http://www.trinity.edu/rjensen/FraudRotten.htm#MutualFunds


    Questions
    How did fraudulent entries enter Madoff's automated accounting systems?
    Why didn't the operations manager detect that something was amiss?

    Madoff's Operations Chief Arrested
    by: Chad Bray
    Feb 26, 2010
    Click here to view the full article on WSJ.com

    TOPICS: Auditing, Fraud, Fraudulent Financial Reporting, Internal Controls, Ponzi Schemes

    SUMMARY: "The longtime director of operations for convicted Ponzi scheme operator Bernard Madoff's defunct firm was arrested and charged criminally Thursday with allegedly directing that false accounting entries be made in the firm's books to conceal Mr. Madoff's fraud."

    CLASSROOM APPLICATION: The article can be used in an accounting class to consider audit steps that should be taken in testing internal controls over segregation of trust funds from operations and over general journal entries. Questions also cover an auditor's responsibility for fraud detection.

    QUESTIONS: 
    1. (Introductory) Who is Bernard Madoff? Of what crime was he convicted? In your answer, define the term Ponzi Scheme.

    2. (Introductory) What are the charges now being made against Mr. Madoff's chief of operations, Daniel Bonventre?

    3. (Advanced) How is it possible for fraudulent entries to be made in an accounting system in an era of automated accounting systems? In your answer, include a discussion of the role of general journal entries versus automated system entries.

    4. (Advanced) What are an outside auditor's responsibilities in detecting fraud and fraudulent financial reporting? What steps must be taken to consider the impact of general journal entries versus other system entries?

    5. (Advanced) What is the difference between investment advisory services and proprietary-trading and market-making operations? Why must funds between these two operations never be commingled?

    6. (Advanced) Refer to your answer to the above question. Devise an audit step to ascertain whether any internal control weaknesses exist that could allow for commingling of funds across these two lines of business.

    Reviewed By: Judy Beckman, University of Rhode Island

     

    "Madoff's Operations Chief Arrested," by Chad Bray, The Wall Street Journal, February 28. 2010 ---
    http://online.wsj.com/article/SB10001424052748704479404575087273271559404.html?mod=djem_jiewr_AC_domainid

    The longtime director of operations for convicted Ponzi scheme operator Bernard Madoff's defunct firm was arrested and charged criminally Thursday with allegedly directing that false accounting entries be made in the firm's books to conceal Mr. Madoff's fraud.

    Prosecutors from the U.S. attorney's office in Manhattan charged Daniel Bonventre, former operations director at Bernard L. Madoff Investment Securities LLC, with conspiracy, securities fraud, falsifying books and records of a broker-dealer, false filings with the Securities and Exchange Commission and four counts of filing false federal-tax returns.

    A lawyer for Mr. Bonventre declined to comment Thursday.

    Mr. Bonventre, 63 years old, made a court appearance in New York on Thursday afternoon, where a judge set his bail at $5 million. He faces as long as 20 years in prison each on the fraud, falsifying-books-and-records and false-filings charges.

    Mr. Bonventre is the sixth person to be charged criminally in the case, including Mr. Madoff himself.

    The SEC also separately brought civil accounting-fraud charges against Mr. Bonventre, alleging he helped disguise Mr. Madoff's fraud and financial losses at the Madoff firm by misusing and improperly recording investor money to create the false appearance of legitimate income.

    "As Bernard Madoff's director of operations, Daniel Bonventre allegedly authored the fraudulent books that for years effectively hid the doomed state of an investment firm founded in fraud," said Preet Bharara, the U.S. attorney in Manhattan.

    Prosecutors alleged Mr. Bonventre directed that false entries be made in the firm's general ledger to conceal the scope of the firm's investment-advisory operations and to understate the firm's liabilities by billions of dollars.

    Mr. Madoff, 71 years old, admitted in March 2009 to running a decades-long Ponzi scheme that bilked thousands of investors. He is serving a 150-year prison term.

    Prosecutors have alleged the Ponzi scheme stretched back to the early 1980s.

    In his plea statement, Mr. Madoff said the scheme was run through the firm's investment-advisory business and that its proprietary-trading and market-making operations were legitimate. In their complaint against Mr. Bonventre, prosecutors alleged that from 1997 to 2008, more than $750 million of investor funds from the investment-advisory business were used to support the proprietary-trading and market-making operations.

    According to the Bonventre complaint, Mr. Madoff's firm experienced a liquidity crisis between November 2005 and June 2006 because demands for withdrawals by investment-advisory clients exceeded cash on hand.

    Because the firm hadn't used client money to purchase securities for those clients in the first place, Mr. Bonventre allegedly was forced to request $145 million in loans from a bank to meet the firm's obligations, prosecutors said. About $154 million in bonds held in investment-advisory clients' accounts were used as collateral for the loans. Prosecutors didn't identify the bank.

    During that period, the firm also drew down more than $340 million from its lines of credit to meet withdrawal requests, prosecutors said. Mr. Bonventre monitored those lines of credit as part of his responsibilities, they said.

    He also allegedly created false records that disguised $262 million in payments to investment-advisory clients from the bank account that funded the firm's operations, prosecutors said. The payments were disguised as purchases of bonds and other debt instruments, they said.

    "A fraud of this magnitude requires a coordinated effort," said George S. Canellos, director of the SEC's New York regional office. "Bonventre played an essential part by creating bogus financial records to give [the Madoff firm] the appearance of legitimacy, when in fact the firm lost money and could not have survived without the fraud."

    Mr. Bonventre joined the Madoff firm in August 1968 and worked there until Mr. Madoff's arrest in December 2008, prosecutors said. He was named the firm's director of operations in 1978.

    Prior to working at the Madoff firm, he was an auditor at a bank, while studying for an associate degree in accounting. He first worked at Mr. Madoff's firm as an auditor, gathering more responsibility for back-office operations over time.

    Mr. Bonventre allegedly had his own investment-advisory account at the firm as far back as 1983. Between 2002 and 2006, he allegedly obtained more than $1.8 million in at least three fictitious backdated trades, prosecutors said.

    The SEC separately alleged his profits from the fake trades were at least $1.9 million. Between 2005 and 2008, Mr. Bonventre also was paid an annual salary of more than $900,000, the SEC said.

    He is charged criminally with filing false tax returns in 2003, in 2004, in 2006 and in 2007.


    Our Main Financial Regulating Agency:  The SEC Screw Everybody Commission
    The Great Ponzi Crooks (R. Allen Stanford and Bernie Madoff) Who Allegedly Manipulated the SEC

    "Ex-SEC Official May Be Prosecuted for Role in Stanford Inquiries," SmartPros, September 23, 2010 ---
    http://accounting.smartpros.com/x70500.xml

    Sept. 23 (The Dallas Morning News) — WASHINGTON -- Federal authorities are considering whether to prosecute a former securities regulator in Fort Worth who repeatedly quashed investigations into whether R. Allen Stanford was running a Ponzi scheme.

    Under questioning at a hearing of the Senate Banking Committee on Wednesday, the Securities and Exchange Commission's inspector general told lawmakers that he's "had discussions with criminal authorities about whether there would be any criminal action arising because of that."

    In a report issued earlier this year, Inspector General David Kotz wrote that Spencer C. Barasch had "a significant role" in decisions over the years not to formally investigate Stanford, who is accused of bilking investors out of $8 billion. The Houston businessman has pleaded not guilty.

    The report said that some SEC examiners thought as early as 1997 that Stanford's financial empire was built on a Ponzi scheme.

    "If you don't get the Justice Department involved in this, shame on you as the inspector general," said Sen. Jim Bunning, R-Ky. "That, to me, is criminal negligence. And the sooner they get him before a U.S. court, the better I will like it."

    Barasch remains a partner in the Dallas office of Andrews Kurth. Bob Jewell, the firm's managing partner, said Wednesday that Kotz's testimony was "disappointing" and that Barasch "served the SEC with honor, integrity and distinction."

    "We disagree with the characterization of Mr. Barasch's involvement put forth by the inspector general," Jewell said in a prepared statement. "We believe he acted properly during his contacts with the Stanford Financial Group and the Securities and Exchange Commission. He did not violate conflicts of interest."

    Kotz also reported that Barasch, who left the SEC in 2005, later represented Stanford before the SEC despite ethics laws against doing so. An SEC spokesman confirmed that the agency's ethics office referred the matter to the State Bar of Texas to consider whether Barasch committed any professional misconduct.

    A spokeswoman for the State Bar said such grievances remain confidential unless a district court or grievance panel sanctions the lawyer.

    Many senators at Wednesday's hearing appeared to be grappling with Kotz's report for the first time.

    The SEC made the report public on the same day in April that it charged Goldman Sachs with fraud, a case that got far more attention in the media. Several senators questioned whether the timing was an attempt to reduce public attention to the inspector general's embarrassing report.

    The report said that SEC examiners in Fort Worth thought as early as 1997 that Stanford might be operating a Ponzi scheme and referred the matter to the enforcement staff. A manager who was leaving the agency told her boss that year that Stanford's business "looks like a Ponzi scheme to me, and someday it's going to blow up," according to Kotz's report.

    However, the enforcement staff opened and closed its case after Stanford refused to voluntarily produce any records. Led by Barasch, the enforcement staff didn't open investigations after three other examinations in 1998, 2002, and 2004 all concluded that Stanford's certificates of deposit were probably a Ponzi scheme or other type of fraud.

    "Any way you look at it, this is a colossal failure of the SEC," said Sen. Richard Shelby, D-Ala.

    The SEC charged Stanford and three of his firms with fraud and other securities violations in February 2009. Rose Romero, the regional director of the SEC in Fort Worth, told lawmakers Wednesday that the SEC has notified other former Stanford employees that it intends to seek fraud charges against them. The group includes "former high level executives and financial advisers," Romero said.

    Kotz said that Barasch and other enforcement attorneys believed the Stanford case was too complex and would absorb too many resources. The group believed that Washington judged regional offices based on how many cases they brought, which led them to pursue easier cases, Kotz said.

    SEC officials generally conceded that they'd missed opportunities to cut off Stanford's alleged fraud.

    The officials said they were implementing several changes to their enforcement priorities, including placing more emphasis on cases that affect a substantial number of investors. The SEC also said it has increased coordination between its examiners -- who originally suspected the Stanford fraud -- and its enforcement staff.

    Robert Khuzami, the SEC's director of enforcement, told the panel that his staff has focused on complex accounting and securities cases, particularly since the credit crisis of 2008.

    "If you look at the course of cases that we have brought in the last 18 months, particularly across the credit crisis -- New Century, Countrywide, Goldman, Dell, State Street, Evergreen, ICP, Citigroup, Bank of America -- these are hugely complicated accounting fraud, structured product cases," Khuzami said.

    "We're not getting quick stats on those cases, I assure you."


    From The Wall Street Journal Accounting Weekly Review on September 10, 2009

    Madoff Report Reveals Extent of Bungling
    by Kara Scannell and Jenny Strasburg
    Sep 05, 2009
    Click here to view the full article on WSJ.com

    TOPICS: Auditing, Ponzi Schemes

    SUMMARY: "The SEC's inspector general released the full 477-page version of his report on how the SEC missed red flags on [Bernard Madoff]....and details just how many opportunities there were for examiners to find the fraud and how bungled their efforts were." For example, "one anonymous complaint directed the SEC to a 'scandal of major proportion' by the Madoff firm and said assets of a specific investor 'have been 'co-mingled' with funds controlled by the Madoff firm. The SEC called Mr. Madoff's lawyer and had him ask Mr. Madoff if he managed money for that investor. When the lawyer said Madoff didn't, the complaint wasn't pursued further. The IG report concludes that 'accepting the word of a registrant who is alleged to be engaged in a specific instance of fraud is an inadequate investigation'....SEC Chairman Mary Schapiro said, 'In the coming weeks, we will continue to closely review the full report and learn every lesson we can to help build upon the many reforms we have already put into place since January.'"

    CLASSROOM APPLICATION: The article makes clear the need for auditing roles at the SEC as well as in public accounting firms auditing general purpose financial statements.

    QUESTIONS: 
    1. (
    Introductory) What is a "Ponzi Scheme"? When was Mr. Madoff convicted of running such a scheme? How did this scheme impact Madoff's investors?

    2. (
    Introductory) Who issued the report on the SEC's failure to uncover the Madoff scheme before it collapsed and he himself admitted to the crime?

    3. (
    Advanced) What did "an unnamed hedge-fund manager" say in an email to the SEC? Explain how each of the points listed in the email indicate the possibility of a Ponzi scheme in operation.

    4. (
    Introductory) What is "front-running" in trading? How did a senior examiner explain this trading activity as his choice of action to investigate in Mr. Madoff's operations?

    5. (
    Advanced) How do you think a choice of action in examination should be determined if the SEC receives a credible indication of possible fraud in operating an investment firm such as Mr. Madoff's? How should this choice drive the determination of expertise needed on an investigatory team?

    6. (
    Advanced) What audit step failure was evident in the SEC investigatory actions undertaken between December 2003 and March 2004, as described in the article?

    7. (
    Introductory) What expertise do you think was needed on the investigative teams handling the Madoff case, at least as described in this article?

    Reviewed By: Judy Beckman, University of Rhode Island

    RELATED ARTICLES: 
    Ex-SEC Lawyer: Madoff Report Misses Point
    by Suzanne Barlyn
    Sep 04, 2009
    Online Exclusive

    'Evil' Madoff Gets 150 Years in Epic Fraud
    by Robert Frank and Amir Efrati
    Jun 30, 2009
    Online Exclusive

     


    New Hints at Why the SEC Failed to Seriously Investigate Madoff's Hedge Fund
    After being repeatedly warned for six years that this was a criminal scam
    It's beginning to look like a family "affair"

    (The SEC's) Swanson later married Madoff's niece, and their relationship is now under review by the SEC inspector general, who is examining the agency's handling of the Madoff case, the Post reported. Swanson, no longer with the agency, declined to comment, the Post said.
    "SEC lawyer raised alarm about Madoff: report," Reuters, July 2, 2009 --- http://news.yahoo.com/s/nm/20090702/bs_nm/us_madoff_sec
    The Washington Post account is at --- Click Here

    A U.S. Securities and Exchange Commission lawyer warned about irregularities at Bernard Madoff's financial management firm as far back as 2004, The Washington Post reported on Thursday, citing agency documents and sources familiar with the investigation.

    Genevievette Walker-Lightfoot, a lawyer in the SEC's Office of Compliance Inspections and Examinations, sent emails to a supervisor saying information provided by Madoff during her review didn't add up and suggesting a set of questions to ask his firm, the report said.

    Several of the questions directly challenged Madoff activities that turned out to be elements of his massive fraud, the newspaper said.

    Madoff, 71, was sentenced to a prison term of 150 years on Monday after he pleaded guilty in March to a decades-long fraud that U.S. prosecutors said drew in as much as $65 billion.

    The Washington Post reported that when Walker-Lightfoot reviewed the paper documents and electronic data supplied to the SEC by Madoff, she found it full of inconsistencies, according to documents, a former SEC official and another person knowledgeable about the 2004 investigation.

    The newspaper said the SEC staffer raised concerns about Madoff but, at the time, the SEC was under pressure to look for wrongdoing in the mutual fund industry. Walker-Lightfoot was told to focus on a separate probe into mutual funds, the report said.

    One of Walker-Lightfoot's supervisors on the case was Eric Swanson, an assistant director of her department, the Post reported, citing two people familiar with the investigation.

    Swanson later married Madoff's niece, and their relationship is now under review by the SEC inspector general, who is examining the agency's handling of the Madoff case, the Post reported.

    Swanson, no longer with the agency, declined to comment, the Post said.

    SEC spokesman John Nester also declined to comment, citing the ongoing investigation by the agency's inspector general, the newspaper said.

    Our Main Financial Regulating Agency:  The SEC Screw Everybody Commission
    One of the biggest regulation failures in history is the way the SEC failed to seriously investigate Bernie Madoff's fund even after being warned by Wall Street experts across six years before Bernie himself disclosed that he was running a $65 billion Ponzi fund.

    CBS Sixty Minutes on June 14, 2009 ran a rerun that is devastatingly critical of the SEC. If you’ve not seen it, it may still be available for free (for a short time only) at http://www.cbsnews.com/video/watch/?id=5088137n&tag=contentMain;cbsCarousel
    The title of the video is “The Man Who Would Be King.”
    Also see http://www.fraud-magazine.com/FeatureArticle.aspx

    Between 2002 and 2008 Harry Markopolos repeatedly told (with indisputable proof) the Securities and Exchange Commission that Bernie Madoff's investment fund was a fraud. Markopolos was ignored and, as a result, investors lost more and more billions of dollars. Steve Kroft reports.

    Markoplos makes the SEC look truly incompetent or outright conspiratorial in fraud.

    I'm really surprised that the SEC survived after Chris Cox messed it up so many things so badly.

    As Far as Regulations Go

    An annual report issued by the Competitive Enterprise Institute (CEI) shows that the U.S. government imposed $1.17 trillion in new regulatory costs in 2008. That almost equals the $1.2 trillion generated by individual income taxes, and amounts to $3,849 for every American citizen. According the 2009 edition of Ten Thousand Commandments: An Annual Snapshot of the Federal Regulatory State, the government issued 3,830 new rules last year, and The Federal Register, where such rules are listed, ballooned to a record 79,435 pages. “The costs of federal regulations too often exceed the benefits, yet these regulations receive little official scrutiny from Congress,” said CEI Vice President Clyde Wayne Crews, Jr., who wrote the report. “The U.S. economy lost value in 2008 for the first time since 1990,” Crews said. “Meanwhile, our federal government imposed a $1.17 trillion ‘hidden tax’ on Americans beyond the $3 trillion officially budgeted” through the regulations.
     Adam Brickley, "Government Implemented Thousands of New Regulations Costing $1.17 Trillion in 2008," CNS News, June 12, 2009 ---
    http://www.cnsnews.com/public/content/article.aspx?RsrcID=49487

    Jensen Comment
    I’m a long-time believer that industries being regulated end up controlling the regulating agencies. The records of Alan Greenspan (FED) and the SEC from Arthur Levitt to Chris Cox do absolutely nothing to change my belief ---
    http://www.trinity.edu/rjensen/FraudRotten.htm

    How do industries leverage the regulatory agencies?
    The primary control mechanism is to have high paying jobs waiting in industry for regulators who play ball while they are still employed by the government. It happens time and time again in the FPC, EPA, FDA, FAA, FTC, SEC, etc. Because so many people work for the FBI and IRS, it's a little harder for industry to manage those bureaucrats. Also the FBI and the IRS tend to focus on the worst of the worst offenders whereas other agencies often deal with top management of the largest companies in America.

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


    "Madoff Inquiry Was Fumbled by S.E.C., Report Says," by David Stout, The New York Times, September 2, 2009 ---
    http://www.nytimes.com/2009/09/03/business/03madoff.html?_r=1&hp

    In a damning report on the S.E.C.’s performance, the agency’s inspector general, H. David Kotz, said numerous “red flags” had been missed by the agency, including some warnings sounded by journalists, well before Mr. Madoff’s Ponzi scheme imploded in 2008.

    Mr. Kotz concluded that, “despite numerous credible and detailed complaints,” the S.E.C. never properly investigated Mr. Madoff “and never took the necessary, but basic, steps to determine if Madoff was operating a Ponzi scheme.”

    “Had these efforts been made with appropriate follow-up at any time beginning in June of 1992 until December 2008, the S.E.C. could have uncovered the Ponzi scheme well before Madoff confessed,” the report concluded.

    That Mr. Madoff’s scheme, estimated to have fleeced as much as $65 billion from investors who ranged from the famous to middle-class people who entrusted him with their life savings, was not caught earlier was not because of his cleverness, the report said. Rather, it was because the S.E.C. fumbled three agency exams and two investigations because of inexperience, incompetence and lack of internal communications.

    Continued in article

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


    "How Bernie Madoff did it:  Madoff is behind bars and isn't talking. But a Fortune investigation uncovers secrets of his massive swindle," by James Bandler, Nicholas Varchaver and Doris Burke, CNN Money, April 24, 2009 ---
    http://money.cnn.com/2009/04/24/news/newsmakers/madoff.brief.fortune/index.htm?cnn=yes

    Since Bernard Madoff was arrested in December and confessed to masterminding a multi-billion Ponzi scheme, countless people have wondered: Who else was involved? Who knew about the fraud? After all, Madoff not only engineered an epic swindle, he insisted to the FBI that he did it all by himself. To date, Madoff has not implicated anybody but himself.

    But the contours of the case are changing.

    Fortune has learned that Frank DiPascali, the chief lieutenant in Madoff's secretive investment business, is trying to negotiate a plea deal with federal prosecutors. In exchange for a reduced sentence, he would divulge his encyclopedic knowledge of Madoff's scheme. And unlike his boss, DiPascali is willing to name names.

    According to a person familiar with the matter, DiPascali has no evidence that other Madoff family members were participants in the fraud. However, he is prepared to testify that he manipulated phony returns on behalf of some key Madoff investors, including Frank Avellino, who used to run a so-called feeder fund, Jeffry Picower, whose foundation had to close as a result of Madoff-related losses, and others.

    If, for example, one of these special customers had large gains on other investments, he would tell DiPascali, who would fabricate a loss to reduce the tax bill. If true, that would mean these investors knew their returns were fishy.

    Explains the source familiar with the matter: "This is a group of inside investors -- all individuals with very, very high net worths who, hypothetically speaking, received a 20% markup or 25% markup or a 15% loss if they needed it." The investors would tell DiPascali, for example, that their other investments had soared and they needed to find some losses to cut their tax bills. DiPascali would adjust their Madoff results accordingly.

    (Gary Woodfield, a lawyer for Avellino, and William Zabel, the attorney for Picower, both declined to comment. Marc Mukasey, DiPascali's laywer, says, "We expect and encourage a thorough investigation.")

    Inside the Madoff swindle: Read the full story --- http://money.cnn.com/2009/04/24/news/newsmakers/madoff.fortune/index.htm

    These special deals for select Madoff investors have become a key focus for federal prosecutors, according to this source and a second one familiar with the investigation. The second source describes the arrangements as "kickbacks" and "bonuses." A spokesperson for the U.S. Attorney declined to comment.

    But a little-noticed line in a public filing by the prosecutors in March supports at least part of these sources' account. The document that formally charged Madoff with his crimes asserted that he "promised certain clients annual returns in varying amounts up to at least approximately 46 percent per year." That was quite a boost when most investors were receiving 10% to 15%. It appears to reflect the benefits that accrued to those who helped bring large sums to Madoff.

    The emergence of this potential star witness is the best news to surface publicly for the Madoff family since the case began. DiPascali has every incentive to implicate high-profile names to save his skin -- and nobody is more under scrutiny than the Madoffs, many of whom worked for the firm. (Representatives for all of the family members have asserted their innocence.) It should be noted that DiPascali is not in a position to say what the Madoffs knew -- this should not be construed as an exoneration. But the fact that a high-ranking participant in the investment operation is not implicating them is telling.

    The DiPascali revelations are part of a special Fortune investigation into the inner workings of Madoff's firm. It chronicles Madoff's rise -- how he started his firm in 1960 with only $200, rose to become a pioneer of electronic trading, and became notorious for his investment operation -- a strange, secretive world supervised by DiPascali.

    DiPascali was a 33-year veteran of Madoff's firm. A high school graduate with a Queens accent, he came to work in an incongruously starched version of a slacker's uniform: pressed jeans, a sweatshirt, and pristine white sneakers or boat shoes. He could often be found outside the building, smoking a cigarette.

    Nobody was quite sure what he did or what his title was. "He was like a ninja," says a former trader in the legitimate operation upstairs. "Everyone knew he was a big deal, but he was like a shadow."

    He may not have looked or acted like a financier, but when customers like the giant feeder fund Fairfield Greenwich came in to talk, DiPascali was usually the only Madoff employee in the room with Bernie. Madoff told the visitors that DiPascali was "primarily responsible" for the investment operation, according to a Fairfield memo.

    And now DiPascali may be primarily responsible for taking the ever-surprising Madoff case in yet another unexpected direction

    Bernard Madoff, former Nasdaq Stock Market chairman and founder of Bernard L. Madoff Investment Securities LLC, was arrested and charged with securities fraud Thursday in what federal prosecutors called a Ponzi scheme that could involve losses of more than $64 billion.

    It is bigger than Enron, bigger than Boesky and bigger than Tyco

    "Madoff Scandal: 'Biggest Story of the Year'," Seeking Alpha, December 12, 2008 ---
    http://seekingalpha.com/article/110402-madoff-scandal-biggest-story-of-the-year?source=wildcard

    According to RealMoney.com columnist Doug Kass, general partner and investment manager of hedge fund Seabreeze Partners Short LP and Seabreeze Partners Short Offshore Fund, Ltd., today's late-breaking report of an alleged massive fraud at a well known investment firm could be "the biggest story of the year." In his view,

    it is bigger than Enron, bigger than Boesky and bigger than Tyco.
    It attacks at the core of investor confidence -- because, if true, and this could happen ... investors might think that almost anything imaginable could happen to the money they have entrusted to their f
    iduciaries.

    Here are some excerpts from the Bloomberg report, entitled "Madoff Charged in $50 Billion Fraud at Advisory Firm":

    Bernard Madoff, founder and president of Bernard Madoff Investment Securities, a market-maker for hedge funds and banks, was charged by federal prosecutors in a $50 billion fraud at his advisory business.

    Madoff, 70, was arrested today at 8:30 a.m. by the FBI and appeared before U.S. Magistrate Judge Douglas Eaton in Manhattan federal court. Charged in a criminal complaint with a single count of securities fraud, he was granted release on a $10 million bond guaranteed by his wife and secured by his apartment. Madoff’s wife was present in the courtroom.

    "It’s all just one big lie," Madoff told his employees on Dec. 10, according to a statement by prosecutors. The firm, Madoff allegedly said, is "basically, a giant Ponzi scheme." He was also sued by the Securities and Exchange Commission.

    Madoff’s New York-based firm was the 23rd largest market maker on Nasdaq in October, handling a daily average of about 50 million shares a day, exchange data show. The firm specialized in handling orders from online brokers in some of the largest U.S. companies, including General Electric Co (GE). and Citigroup Inc. (C).

    ...

    SEC Complaint

    The SEC in its complaint, also filed today in Manhattan federal court, accused Madoff of a "multi-billion dollar Ponzi scheme that he perpetrated on advisory clients of his firm."

    The SEC said it’s seeking emergency relief for investors, including an asset freeze and the appointment of a receiver for the firm. Ira Sorkin, another defense lawyer for Madoff, couldn’t be immediately reached for comment.

    ...

    Madoff, who owned more than 75 percent of his firm, and his brother Peter are the only two individuals listed on regulatory records as "direct owners and executive officers."

    Peter Madoff was a board member of the St. Louis brokerage firm A.G. Edwards Inc. from 2001 through last year, when it was sold to Wachovia Corp (WB).

    $17.1 Billion

    The Madoff firm had about $17.1 billion in assets under management as of Nov. 17, according to NASD records. At least 50 percent of its clients were hedge funds, and others included banks and wealthy individuals, according to the records.

    ...

    Madoff’s Web site advertises the "high ethical standards" of the firm.

    "In an era of faceless organizations owned by other equally faceless organizations, Bernard L. Madoff Investment Securities LLC harks back to an earlier era in the financial world: The owner’s name is on the door," according to the Web site. "Clients know that Bernard Madoff has a personal interest in maintaining the unblemished record of value, fair-dealing, and high ethical standards that has always been the firm’s hallmark."

    ...

    "These guys were one of the original, if not the original, third market makers," said Joseph Saluzzi, the co-head of equity trading at Themis Trading LLC in Chatham, New Jersey. "They had a great business and they were good with their clients. They were around for a long time. He’s a well-respected guy in the industry."

    The case is U.S. v. Madoff, 08-MAG-02735, U.S. District Court for the Southern District of New York (Manhattan)

    Continued in article

    And here is the SEC press release

    Also see http://lawprofessors.typepad.com/securities/

    What was the auditing firm of Bernard Madoff Investment Securities, the auditor who gave a clean opinion, that's been insolvent for years?
    Apparently, Mr Madoff said the business had been insolvent for years and, from having $17 billion of assets under management at the beginning of 2008, the SEC said: “It appears that virtually all assets of the advisory business are gone”. It has now emerged that Friehling & Horowitz, the auditor that signed off the annual financial statement for the investment advisory business for 2006, is under investigation by the district attorney in New York’s Rockland County, a northern suburb of New York City.
    "The $50bn scam: How Bernard Madoff allegedly cheated investors," London Times, December 15, 2008 ---
    http://business.timesonline.co.uk/tol/business/industry_sectors/banking_and_finance/article5345751.ece

    It was at the Manhattan apartment that Mr Madoff apparently confessed that the business was in fact a “giant Ponzi scheme” and that the firm had been insolvent for years.

    To cap it all, Mr Madoff told his sons he was going to give himself up, but only after giving out the $200 - $300 million money he had left to “employees, family and friends”.

    All the company’s remaining assets have now been frozen in the hope of repaying some of the companies, individuals and charities that have been unfortunate enough to invest in the business.

    However, with the fraud believed to exceed $50 billion, whatever recompense investors could receive will be a drop in the ocean.

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


    "IT'S THE HOUSE THAT RUTH LOST MRS. MADOFF SUFFERS $UITE REVENGE," by Bruce Golding, The New York Post, June 27, 2009 ---
    http://www.nypost.com/seven/06272009/news/regionalnews/its_the_house_that_ruth_lost_176389.htm

    Ruth Madoff agreed yesterday to give up her deluxe apartment on the Upper East Side as part of a massive surrender of more than $80 million in cash and property to cover a bit of the billions looted by her Ponzi-scheming hubby, Bernie.

    Under terms of the deal, the former jet-setters will have to cough up a treasure trove of loot, including more than $46 million in securities and $13 million in cash that Ruth formerly claimed wasn't tainted by her husband's crimes.

    The Madoffs will also have to fork over the couple's $7 million beachfront home in Montauk, LI, a $7.5 million property in Palm Beach, Fla., tens of millions in loans to family members and a 55-foot yacht named "Bull."

    Federal prosecutors are letting the Ponzi king's wife hold on to only $2.5 million they couldn't tie directly to his $65 billion mega-fraud.

    But the agreement -- inked just three days before Madoff faces sentencing of up to 150 years in prison -- offers his wife no protection from collection efforts by other government agencies or other parties, including the bankruptcy trustees seeking funds for his many wiped-out investors.

    Court papers don't indicate how soon Ruth will have to scoot from her $7.5 million penthouse, but the feds say they plan "to distribute, as soon as practicable, the net proceeds from the sale . . . to victims of the offenses of which [Bernard] Madoff was convicted."

    The US Marshals Service, which will handle the sale of the East 64th Street duplex, will also "facilitate the expeditious disposition of the personal property" inside.

    Those goodies include a $65,000 set of silverware and a $39,000 Steinway piano, court papers say.

    Ruth initially balked at surrendering her pricey pad after the feds began the forfeiture proceedings following Bernard's guilty plea in March.

    The massive transfer of booty as part of the judgment is only a drop in the bucket of the $171 billion judgment entered against Bernie, covering every nickel that passed through his crooked investment-advisory business.

    In other court papers filed yesterday, prosecutors urged Judge Denny Chin to sentence Bernie Monday to the maximum 150 years in prison.

    "The scope, duration and nature of Madoff's crimes render him exceptionally deserving of the maximum punishment allowed by law," prosecutors Marc Litt and Lisa Baroni said.

    As an alternative, they suggested "a term of years that . . . would assure that Madoff will remain in prison for life."

    The feds also attacked arguments made earlier this week by defense lawyer Ira Lee Sorkin, who said Madoff, 71, should get a 12-year term based on his life expectancy of only 13 more years.

    Such a short sentence, the prosecutors said, "would not distinguish this case from the mine run of securities-fraud cases that in this district regularly result in sentences of 10 to 15 years."

    By comparison, they noted that his scheme -- which caused at least $13 billion in actual losses -- greatly exceeded the crimes of other white-collar crooks, including WorldCom's Bernard Ebbers, who got 25 years, and hedge-fund scammer Samuel Israel III, who got 20.

    Jensen Comment
    Meanwhile Bernie himself is pleading for 12 years or less in prison, which averages out to one year or less for every $5 billion that he stole. He probably has a billion or two hidden away for those "massages" he can sneak in when Ruth's back is turned.

    Our Main Financial Regulating Agency:  The SEC Screw Everybody Commission
    One of the biggest regulation failures in history is the way the SEC failed to seriously investigate Bernie Madoff's fund even after being warned by Wall Street experts across six years before Bernie himself disclosed that he was running a $65 billion Ponzi fund.

    CBS Sixty Minutes on June 14, 2009 ran a rerun that is devastatingly critical of the SEC. If you’ve not seen it, it may still be available for free (for a short time only) at http://www.cbsnews.com/video/watch/?id=5088137n&tag=contentMain;cbsCarousel
    The title of the video is “The Man Who Would Be King.”
    Also see http://www.fraud-magazine.com/FeatureArticle.aspx

    Between 2002 and 2008 Harry Markopolos repeatedly told (with indisputable proof) the Securities and Exchange Commission that Bernie Madoff's investment fund was a fraud. Markopolos was ignored and, as a result, investors lost more and more billions of dollars. Steve Kroft reports.

    Markoplos makes the SEC look truly incompetent or outright conspiratorial in fraud.

    I'm really surprised that the SEC survived after Chris Cox messed it up so many things so badly.

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


    Where were the auditors?
    What surprised me is the size of this alleged fraud
    "This is huge," said David Rosenfeld, associate regional director of the SEC's New York Regional Office.
    "This is a truly egregious fraud of immense proportions."

    "Carnegie Mellon and Pitt Accuse 2 Investment Managers of $114-Million Fraud," by Scott Carlson, Chronicle of Higher Education, February 26, 2009 --- Click Here

    The University of Pittsburgh and Carnegie Mellon University are suing two investment managers who allegedly took $114-million from the institutions and spent it on cars, horses, houses for their wives, and even teddy bears.

    The two managers, Paul Greenwood and Stephen Walsh, are said to have taken a total of more than $500-million from the universities and other investors through their company, Westridge Capital Management, and they have also been charged with fraud by the Federal Bureau of Investigation. The universities named several associates of Mr. Greenwood and Mr. Walsh in the lawsuit.

    According to the complaint, the universities became alarmed after the National Futures Association, a nonprofit organization that investigates member firms, tried to audit Mr. Greenwood and Mr. Walsh’s company. The association determined that that Mr. Greenwood and Mr. Walsh had taken hundreds of millions in loans from the investment funds. On February 12 the association suspended their membership after repeatedly trying, and failing, to contact them.

    That step spurred the universities to try to locate their money. On February 18 they contacted the Securities and Exchange Commission and sought an investigation. According to their lawsuit, Carnegie Mellon had invested $49-million and the University of Pittsburgh had invested $65-million.

    Today’s Pittsburgh Post-Gazette listed some of the things that Mr. Greenwood and Mr. Walsh had purchased with their investors’ money: rare books, Steiff teddy bears at up to $80,000 each, a horse farm, cars, and a $3-million residence for Mr. Walsh’s ex-wife.

    Mr. Greenwood and Mr. Walsh were also handling money for retirement funds for teachers and public employees in Iowa, North Dakota, and Sacramento County, California. In the Post-Gazette, David Rosenfeld, an associate regional director of the SEC’s New York Regional Office, said the case represented “a truly egregious fraud of immense proportions.”

    Mr. Walsh, it appears, had ties to another university as well. He is a member of the foundation board at the State University of New York at Buffalo, from which he graduated in 1966 with a political-science degree. In a written statement, officials at Buffalo said that he had not been an active board member for the past two years and that foundation policy forbade investing university money with any member of the board.

    "Pitt, CMU money managers arrested in fraud FBI says they misappropriated $500 million for lavish lifestyles," by Jonathon Silver, Pittsburgh Post-Gazette, February 26, 2009 --- http://www.post-gazette.com/pg/09057/951834-85.stm

    Two East Coast investment managers sued for fraud by the University of Pittsburgh and Carnegie Mellon University misappropriated more than $500 million of investors' money to hide losses and fund a lavish lifestyle that included purchases of $80,000 collectible teddy bears, horses and rare books, federal authorities said yesterday.

    As Pitt and Carnegie Mellon were busy trying to learn whether they will be able to recover any of their combined $114 million in investments through Westridge Capital Management, the FBI yesterday arrested the corporations' managers.

    Paul Greenwood, 61, of North Salem, N.Y., and Stephen Walsh, 64, of Sands Point, N.Y., were charged in Manhattan -- by the same office prosecuting the Bernard L. Madoff fraud case -- with securities fraud, wire fraud and conspiracy.

    Both men also were sued in civil court by the U.S. Securities and Exchange Commission and the Commodity Futures Trading Commission, which alleged that the partners misappropriated more than $553 million and "fraudulently solicited" $1.3 billion from investors since 1996.

    The Accused

    Paul Greenwood and Stephen Walsh are accused of misappropriating millions from investors. Here is a look at some of their biggest personal purchases:

    • HOME: Mr. Greenwood, a horse breeder, owned a horse farm in North Salem, N.Y., an affluent community that counts David Letterman as a resident.

    • BEARS: Mr. Greenwood owns as many as 1,350 Steiff toys, including teddy bears costing as much as $80,000.

    • DIVORCE: Mr. Walsh bought his ex-wife a $3 million condominium as part of their divorce settlement.

    "This is huge," said David Rosenfeld, associate regional director of the SEC's New York Regional Office. "This is a truly egregious fraud of immense proportions."

    Lawyers for the defendants either could not be reached or had no comment.

    Mr. Greenwood and Mr. Walsh, longtime associates and former co-owners of the New York Islanders hockey team, ran Westridge Capital Management and a number of affiliated funds and entities.

    As late as this month, the partners appeared to be doing well. Mr. Greenwood told Pitt's assistant treasurer Jan. 21 that they had $2.8 billion under management -- though that number is now in question. And on Feb. 2, Pitt sent $5 million to be invested.

    But in the course of less than three weeks, Westridge's mammoth portfolio imploded in what federal authorities called an investment scam meant to cover up trading losses and fund extravagant purchases by the partners.

    An audit launched Feb. 5 by the National Futures Association proved key to uncovering the alleged deceit and apparently became the linchpin of the case federal prosecutors are building.

    That audit came about in an indirect way. The association, a self-policing membership body, had taken action against a New York financier. That led to a man named Jack Reynolds, a manager of the Westridge Capital Management Fund in which CMU invested $49 million; and Mr. Reynolds led to Westridge.

    "We just said we better take a look at Jack Reynolds and see what's happening, and that led us to Westridge and WCM, so it was a domino effect," said Larry Dyekman, an association spokesman. "We're just not sure we have the full picture yet."

    Mr. Reynolds has not been charged by federal authorities, but he is named as a defendant in the lawsuit that was filed last week by Pitt and CMU.

    "Greenwood and Walsh refused to answer any of our questions about where the money was or how much there was," Mr. Dyekman continued.

    "This is still an ongoing investigation, and we can't really say at this point with any finality how much has been lost."

    The federal criminal complaint traces the alleged illegal activity to at least 1996.

    FBI Special Agent James C. Barnacle Jr. said Mr. Greenwood and Mr. Walsh used "manipulative and deceptive devices," lied and withheld information as part of a scheme to defraud investors and enrich themselves.

    The complaint refers to a public state-sponsored university called "Investor 1" whose details match those given by Pitt in its lawsuit.

    The SEC's Mr. Rosenfeld said the fraud hinged not so much on the partners' investment strategy but on the fact that they are believed to have simply spent other people's money on themselves.

    "They took it. They promised the investors it would be invested. And instead of doing that they misappropriated it for their own use," Mr. Rosenfeld said.

    Not only do federal authorities believe Mr. Greenwood and Mr. Walsh used new investors' funds to cover up prior losses in a classic Ponzi scheme, they used more than $160 million for personal expenses including:

    • Rare books bought at auction;

    • Steiff teddy bears purchased for up to $80,000 at auction houses including Sotheby's;

    • A horse farm;

    • Cars;

    • A residence for Mr. Walsh's ex-wife, Janet Walsh, 53, of Florida, for at least $3 million;

    • Money for Ms. Walsh and Mr. Greenwood's wife, Robin Greenwood, 57, both of whom are defendants in the SEC suit. More than $2 million was allegedly wired to their personal accounts by an unnamed employee of the partners.

    "Defendants treated investor money -- some of which came from a public pension fund -- as their own piggy bank to lavish themselves with expensive gifts," said Stephen J. Obie, the Commodity Futures Trading Commission's acting director of enforcement.

    It is not clear how Pitt and CMU got involved with Mr. Greenwood and Mr. Walsh. But there is at least one connection involving academia. The commission suit said Mr. Walsh represented to potential investors that he was a member of the University at Buffalo Foundation board and served on its investment committee.

    Mr. Walsh is a 1966 graduate of the State University of New York at Buffalo where he majored in political science.

    He was a trustee of the University at Buffalo Foundation, but the foundation did not have any investments in Westridge or related firms.

    Universities, charitable organizations, retirement and pension funds are among the investors who have done business with Mr. Greenwood and Mr. Walsh.

    Among those investors are the Sacramento County Employees' Retirement System, the Iowa Public Employees' Retirement System and the North Dakota Retirement and Investment Office, which handles $4 billion in investments for teachers and public employees.

    The North Dakota fund received about $20 million back from Westridge Capital Management, but has an undetermined amount still out in the market, said Steve Cochrane, executive director.

    Mr. Cochrane said Westridge Capital was cooperative in returning what money it could by closing out their position and sending them the money.

    "I dealt with them exclusively all these years," Mr. Cochrane said.

    "They always seemed to be upfront and honest. I think they're as stunned and as victimized as we are, is my guess."

    He said Westridge Capital had done an excellent job over the years.

    The November financial statement indicated that the one-year return from Westridge Capital was a negative 11.87 percent, but the five-year annualized rate of return was a positive 8.36 percent.

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

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


    Bernard Madoff's Gangster Family Seems to Have Been Overlooked by Investors

    "Pretty v. Ugly at the University," University Diaries Blog, Inside Higher Ed, February 24, 2009 --- http://www.insidehighered.com/blogs/university_diaries

    Bernard Madoff is a classic Mafia-style gangster. He comes from gangsters - his mother was a crook. Investigators are looking into his father-in-law. A lot of his friends and investors are crooks. He was born a crook, has always been a crook.

    "The FBI believes Madoff may never have properly invested any of the money entrusted to him," writes Stephen Foley in The Independent. That's <em>never</em>. Madoff is in his seventies.

    Psychopathically evil, Madoff makes an exception - again, Mafia-style - for his closest family and friends. His last act before turning himself in was writing big checks to the inner circle.

    Tomorrow, Harry Markopolos will tell Congress how easy it was, ten years ago, for him to prove that Madoff was a crook, and how difficult it was for him to convince the SEC, or anyone else, of this obvious truth.

    An ugly story, isn't it.... Ugh. Let us turn to the verdant paths of Brandeis University, and walk to the door of its art museum, where pretty canvases hang on the walls and rekindle our sense of the beauty of the world and the goodness of mankind.

    Yet all of this beauty will soon be shuttered, because that ugly world is all over Brandeis. It's all over a number of other universities, too -- Yeshiva, Bard, NYU, all the schools who loved charitable Bernie Madoff and his charitable friends.

    Madoff, after all, was a philanthropist.

    Not that he, as the word suggests, loves people. He hates people.

    But he (and benefactors like Carl Shapiro, his closest business associate) gave lots of money to pretty places like universities, places that stand for love, not hate, and beauty, not ugliness. Why did he do that?

    For the same reason many other crooks do it. To get their names on buildings, and, much more importantly, to launder their images. Madoff's been cleaning himself up for public consumption all his life, and there's nothing like gifts to universities to do oneself up <em>real</em> good.

    University Diaries has covered, over the years, many amusing stories of universities using the latest in stone-blasting technology to get the names of crooks off of buildings the crooks endowed. At any given time, some university in this country is using power tools on its walls in a desperate effort to dissociate itself from scum. Here's the latest case. One of the most amusing was Dennis Kozlowski at Seton Hall.

    Even if it doesn't call for power tools, the problem of taking crooks' money can be just as troublesome, as with the University of Missouri-Columbia's Kenneth L. Lay Chair in International Economics.

    Sometimes things call for quick-action internet prowess. Recall how, deep in the pre-exposure night, Yeshiva University deleted from its webpages the once-sainted names of Bernard Madoff and his partner, Ezra Merkin.

    Our wretched economy will continue to reveal the reputation-laundering enterprise some of our universities have been running.

    Just as every Madoff associate or victim claims to be a deceived innocent, so these campuses will tell us they never suspected a thing.

    The farce would be fun to watch if it weren't so incredibly destructive.

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

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

     

     

     


    Exploiting the Poor

    Inside U.S. companies' audacious drive to extract more profits from the nation's working poor

    "The Poverty Business," by Brian Grow and Keith Epstein, Business Week Cover Story, May 21, 2007 --- http://www.businessweek.com/magazine/content/07_21/b4035001.htm

    In recent years, a range of businesses have made financing more readily available to even the riskiest of borrowers. Greater access to credit has put cars, computers, credit cards, and even homes within reach for many more of the working poor. But this remaking of the marketplace for low-income consumers has a dark side: Innovative and zealous firms have lured unsophisticated shoppers by the hundreds of thousands into a thicket of debt from which many never emerge.

    Federal Reserve data show that in relative terms, that debt is getting more expensive. In 1989 households earning $30,000 or less a year paid an average annual interest rate on auto loans that was 16.8% higher than what households earning more than $90,000 a year paid. By 2004 the discrepancy had soared to 56.1%. Roughly the same thing happened with mortgage loans: a leap from a 6.4% gap to one of 25.5%. "It's not only that the poor are paying more; the poor are paying a lot more," says Sheila C. Bair, chairman of the Federal Deposit Insurance Corp.

    Once, substantial businesses had little interest in chasing customers of the sort who frequent the storefronts surrounding the Byrider dealership in Albuquerque. Why bother grabbing for the few dollars in a broke man's pocket? Now there's a reason.

    Armed with the latest technology for assessing credit risks—some of it so fine-tuned it picks up spending on cigarettes—ambitious corporations like Byrider see profits in those thin wallets. The liquidity lapping over all parts of the financial world also has enabled the dramatic expansion of lending to the working poor. Byrider, with financing from Bank of America Corp. (
    BAC ) and others, boasts 130 dealerships in 30 states. At company headquarters in Carmel, Ind., a profusion of colored pins decorates wall maps, marking the 372 additional franchises it aims to open from California to Florida. CompuCredit Corp., based in Atlanta, aggressively promotes credit cards to low-wage earners with a history of not paying their bills on time. And BlueHippo Funding, a self-described "direct response merchandise lender," has retooled the rent-to-own model to sell PCs and plasma TVs.

    The recent furor over subprime mortgage loans fits into this broader story about the proliferation of subprime credit. In some instances, marketers essentially use products as the bait to hook less-well-off shoppers on expensive loans. "It's the finance business," explains Russ Darrow Jr., a Byrider franchisee in Milwaukee. "Cars happen to be the commodity that we sell." In another variation, tax-preparation services offer instant refunds, skimming off hefty fees. Attorneys general in several states say these techniques at times have violated consumer-protection laws.

    Some economists applaud how the spread of credit to the tougher parts of town has raised home- and auto-ownership rates. But others warn that in the long run the development could slow upward mobility. Wages for the working poor have been stagnant for three decades. Meanwhile, their spending has consistently and significantly exceeded their income since the mid-1980s. They are making up the difference by borrowing more. From 1989 through 2004, the total amount owed by households earning $30,000 or less a year has grown 247%, to $691 billion, according to the most recent Federal Reserve data available.

    "Having access to credit should be helping low-income individuals," says Nouriel Roubini, an economics professor at New York University's Stern School of Business. "But instead of becoming an opportunity for upward social and economic mobility, it becomes a debt trap for many trying to move up."

    HAPPY AS SHE WAS with the Saturn (
    GM ) she bought in December, 2005, Roxanne Tsosie soon ran into trouble paying off the loan on it. The car had 103,000 miles on the odometer. She agreed to a purchase price of $7,922, borrowing the full amount at a sky-high 24.9%. Based on her conversation with the Byrider salesman, she thought she had signed up for $150 monthly installments. The paperwork indicated she owed that amount every other week. She soon realized she couldn't manage the payments. Dejected, she agreed to give the car back, having already paid $900. "It kind of knocked me down," Tsosie says. "I felt I'd never get anywhere."

    The abortive purchase meant Byrider could dust off and resell the Saturn. Nearly half of Byrider sales in Albuquerque do not result in a final payoff, and many vehicles are repossessed, says David Brotherton, managing partner of the dealership. A former factory worker, he says he sympathizes with customers who barely get by. "Many of these people are locked in a perpetual cycle" of debt, he says. "It's all motivated by self-interest, of course, but we do want to help credit-challenged people get to the finish line."

    Byrider dealers say they can generally figure out which customers will pay back their loans. Salesmen, many of whom come from positions at banks and other lending companies, use proprietary software called Automated Risk Evaluator (ARE) to assess customers' financial vital signs, ranging from credit scores from major credit agencies to amounts spent on alimony and cigarettes.

    Unlike traditional dealers, Byrider doesn't post prices—which average $10,200 at company-owned showrooms—directly on its cars. Salesmen, after consulting ARE, calculate the maximum that a person can afford to pay, and only then set the total price, down payment, and interest rate. Byrider calls this process fair and accurate; critics call it "opportunity pricing."

    So how did Byrider figure that Tsosie had $300 a month left over from her small salary for car payments? Barely a step up from destitution, she now lives in her own cramped apartment in a dingy two-story adobe-style building. Decorated with an old bow and arrow and sepia-tinted photographs of Navajo chiefs, the apartment is also home to her new husband, Joey A. Garcia, a grocery-store stocker earning $25,000 a year, his two children from a previous marriage, and two of Tsosie's kids. She and Garcia are paying off several other high-interest loans, including one for his used car and another for the $880 wedding ring he bought her this year.

    Asked by BusinessWeek to review Tsosie's file, Byrider's Brotherton raises his eyebrows, taps his keyboard, and studies the screen for a few minutes. "We probably should have spent more time explaining the terms to her," he says. Pausing, he adds that given Tsosie's finances, she should never have received a 24.9% loan for nearly $8,000.

    That still leaves her $900 in Byrider's till. "No excuses; I apologize," Brotherton says. He promises to return the money (and later does). In most transactions, of course, there's no reporter on the scene asking questions.

    A QUARTER-CENTURY ago, Byrider's founder, the late James F. Devoe, saw before most people the untapped profits in selling expensive, highly financed products to marginal customers. "The light went on that there was a huge market of people with subprime and unconventional credit being turned down," says Devoe's 38-year-old son, James Jr., who is now chief executive.

    The formula produces profits. Last year, net income on used cars sold by outlets Byrider owns averaged $828 apiece. That compared with only $223 for used cars sold as a sideline by new-car dealers, and a $31 loss for the typical new car, according to the National Automobile Dealers Assn. Nationwide, Byrider dealerships reported sales last year of $700 million, up 7% from 2005.

    "Good Cars for People Who Need Credit," the company declares in its sunny advertising, but some law enforcers say Byrider's inventive sales techniques are unfair. Joel Cruz-Esparza, director of consumer protection in the New Mexico Attorney General's Office from 2002 to 2006, says he received numerous complaints from buyers about Byrider. His office contacted the dealer, but he never went to court. "They're taking advantage of people, but it's not illegal," he says.

    Officials elsewhere disagree. Attorneys general in Kentucky and Ohio have alleged in recent civil suits that opportunity pricing misleads customers. Without admitting liability, Byrider and several franchises settled the suits in 2005 and 2006, agreeing to inform buyers of "maximum retail prices." Dealers now post prices somewhere on their premises, though still not on cars. Doing so would put them "at a competitive disadvantage," says CEO Devoe. Sales reps flip through charts telling customers they have the right to know prices. Even so, Devoe says, buyers "talk to us about the price of the car less than 10% of the time."

    Tsosie recently purchased a 2001 Pontiac from another dealer. She's straining to make the $277 monthly payment on a 14.9% loan.

    Nobody, poor or rich, is compelled to pay a high price for a used car, a credit card, or anything else. Some see the debate ending there. "The only feasible way to run a capitalist society is to allow companies to maximize their profits," says Tyler Cowen, an economist at George Mason University in Fairfax, Va. "That will sometimes include allowing them to sell things to people that will sometimes make them worse off."

    Others worry, however, that the widening income gap between the wealthy and the less fortunate is being exacerbated by the spread of high-interest, high-fee financing. "People are being encouraged to live beyond their means by companies that are preying on low-income consumers," says Jacob S. Hacker, a political scientist at Yale.

    Higher rates aren't deterring low-income borrowers. Payday lenders, which provide expensive cash advances due on the customer's next payday, have multiplied from 300 in the early 1990s to more than 25,000. Savvy financiers are rolling up payday businesses and pawn shops to form large chains. The stocks of five of these companies now trade publicly on the New York Stock Exchange (
    NYX ) and NASDAQ (NDAQ ). The investment bank Stephens Inc. estimates that the volume of "alternative financial services" provided by these sorts of businesses totals more than $250 billion a year.

    Mainstream financial institutions are helping to fuel this explosion in subprime lending to the working poor. Wells Fargo & Co. (
    WFC ) and U.S. Bancorp (USB ) now offer their own versions of payday loans, charging $2 for every $20 borrowed. Based on a 30-day repayment period, that's an annual interest rate of 120%. (Wells Fargo says the loans are designed for emergencies, not long-term financial needs.) Bank of America's revolving credit line to Byrider provides up to $110 million. Merrill Lynch & Co. (MER ) works with CompuCredit to package credit-card receivables as securities, which are bought by hedge funds and other big investors.

    Once, major banks and companies avoided the poor side of town. "The mentality was: Low income means low revenue, so let's not locate there," says Matt Fellowes, a researcher at the Brookings Institution in Washington, D.C. Now, he says, a growing number of sizable corporations are realizing that viewed in the aggregate, the working poor are a choice target. Income for the 40 million U.S. households earning $30,000 or less totaled $650 billion in 2004, according to Federal Reserve data.

    John T. Hewitt, a pioneer in the tax-software industry, recognized the opportunity. The founder of Jackson Hewitt Tax Service Inc. (
    JTX ) says that as his company grew in the 1980s, "we focused on the low-hanging fruit: the less affluent people who wanted their money quick."

    In the 1990s, Jackson Hewitt franchises blanketed lower-income neighborhoods around the country. They soaked up fees not just by preparing returns but also by loaning money to taxpayers too impatient or too desperate to wait for the government to send them their checks. During this period, Congress expanded the Earned-Income Tax Credit, a program that guarantees refunds to the working poor. Jackson Hewitt and rival tax-prep firms inserted themselves into this wealth-transfer system and became "the new welfare office," observes Kathryn Edin, a visiting professor at Harvard University's John F. Kennedy School of Government. Today, recipients of the tax credit are Jackson Hewitt's prime customers.

    "Money Now," as Jackson Hewitt markets its refund-anticipation loans, comes at a steep price. Lakissisha M. Thomas learned that the hard way. For years, Thomas, 29, has bounced between government assistance and low-paying jobs catering to the wealthy of Hilton Head Island, S.C. She worked most recently as a cashier at a jewelry store, earning $8.50 an hour, until she was laid off in April. The single mother lives with her five children in a dimly lit four-bedroom apartment in a public project a few hundred yards from the manicured entrance of Indigo Run, a resort where homes sell for more than $1 million.

    Thomas finances much of what she buys, but admits she usually doesn't understand the terms. "What do you call it—interest?" she asks, sounding confused. Two years ago she borrowed $400 for rent and food from Advance America Cash Advance Centers Inc. (
    AEA ), a payday chain. She renewed the loan every two weeks until last November, paying more than $2,500 in fees.

    This January, eager for a $4,351 earned-income credit, she took out a refund-anticipation loan from Jackson Hewitt. She used the money to pay overdue rent and utility bills, she says. "I thought it would help me get back on my feet."

    A public housing administrator who reviews tenants' tax returns pointed out to Thomas that Jackson Hewitt had pared $453, or 10.4%, in tax-prep fees and interest from Thomas' anticipated refund. Only then did she discover that various services for low-income consumers prepare taxes for free and promise returns in as little as a week. "Why should I pay somebody else, some big company, when I could go to the free service?" she asks.

    The lack of sophistication of borrowers like Thomas helps ensure that the Money Now loan and similar offerings remain big sellers. "I don't know whether I was more bothered by the ignorance of the customers or by the company taking advantage of the ignorance of the customers," says Kehinde Powell, who worked during 2005 as a preparer at a Jackson Hewitt office in Columbus, Ohio. She changed jobs voluntarily.

    State and federal law enforcers lately have objected to some of Jackson Hewitt's practices. In a settlement in January of a suit brought by the California Attorney General's Office, the company, which is based in Parsippany, N.J., agreed to pay $5 million, including $4 million in consumer restitution. The state alleged Jackson Hewitt had pressured customers to take out expensive loans rather than encourage them to wait a week or two to get refunds for free. The company denied liability. In a separate series of suits filed in April, the U.S. Justice Dept. alleged that more than 125 Jackson Hewitt outlets in Chicago, Atlanta, Detroit, and the Raleigh-Durham (N.C.) area had defrauded the Treasury by seeking undeserved refunds.

    Jackson Hewitt stressed that the federal suits targeted a single franchisee. The company announced an internal investigation and stopped selling one type of refund-anticipation loan, known as a preseason loan. The bulk of refund loans are unaffected. More broadly, the company said in a written statement prepared for BusinessWeek that customers are "made aware of all options available," including direct electronic filing with the IRS. Refund loan applicants, the company said, receive "a variety of both verbal and written disclosures" that include cost comparisons. Jackson Hewitt added that it provides a valuable service for people who "have a need for quick access to funds to meet a timely expense." The two franchises that served Thomas declined to comment or didn't return calls.

    VINCENT HUMPHRIES, 61, has watched the evolution of low-end lending with a rueful eye. Raised in Detroit and now living in Atlanta, he never got past high school. He started work in the early 1960s at Ford Motor Co.'s hulking Rouge plant outside Detroit for a little over $2 an hour. Later he did construction, rarely earning more than $25,000 a year while supporting five children from two marriages. A masonry business he financed on credit cards collapsed. None of his children have attended college, and all hold what he calls "dead-end jobs."

    Over the years he has "paid through the nose" for used cars, furniture, and appliances, he says. He has borrowed from short-term, high-interest lenders and once worked as a deliveryman for a rent-to-own store in Atlanta that allowed buyers to pay for televisions over time but ended up charging much more than a conventional retailer. "You would have paid for it three times," he says. As for himself, he adds: "I've had plenty of accounts that have gone into collection. I hope I can pay them before I die." His biggest debts now are medical bills related to a heart condition. He lives on $875 a month from Social Security.

    Continued in article

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

     

     

     


    Fraud Around the World

    That some bankers have ended up in prison is not a matter of scandal, but what is outrageous is the fact that all the others are free.
    Honoré de Balzac

    China, which executes more criminals than the rest of the world combined, usually puts inmates to death with a gunshot to the back of the head, but has recently experimented with lethal injections.
    See below

    "China executes bank employees in fraud crackdown," BEIJING, Sept 14, 2004 (Reuters)  

     

    China executed four people, including employees of two of its Big Four state banks, for fraud totalling $15 million, the Xinhua state news agency said on Tuesday, amidst a high-profile campaign against financial
    crime.


     The executions come after a string of arrests in white-collar crime as China prepares to sell shares in its big
    banks.  The latest cases involved China Construction Bank, due to
    raise up to $10 billion in an IPO next year, and Bank of Chin -- which is moving towards an IPO worth up to $4 billion.


     Wang Liming, a former accounting officer at China Construction Bank in the central province of Henan, worked with others to steal 20 million yuan ($2.4 million) from the bank using fake papers, Xinhua said in a report on its Web site: (www.xinhuanet.com). An accomplice, Miao Ping, was also executed.
        

    Another Construction Bank employee, Wang Xiang, was executed for taking 20 million yuan from the bank in an unrelated case.  Liang Shihan, an official at the Bank of China's branch in
    the southern city of Zhuhai, helped cheat his bank out of $10.3 million, Xinhua said.


     Xinhua did not say how the four were killed. China, which executes more criminals than the rest of the world combined, usually puts inmates to death with a gunshot to the back of the head, but has recently experimented with lethal injections.


     The debt-laden state banks have been involved in other fraud scandals as Beijing tries to clean them up ahead of 2007, when the sector opens fully to foreign rivals as part of pledges made to the World Trade Organisation.
        

    China arrested Liu Jinbao, former chief of the Bank of China's Hong Kong branch, for corruption in February. Last December, Wang Xuebing, former head of Construction Bank, was sentenced to 12 years in prison for taking bribes.
        

    The government injected a combined $45 billion into Construction Bank and Bank of China last year as part of a
    pilot scheme to reform the sector and prepare for the IPOs.  

     

    The precise number of people executed in China is a secret  Reports range from 5,000 to 10,000 a year, many for murder, but also for corruption and crimes as minor as bottom-pinching.

    Legal experts have called for a ``kill fewer, kill carefully'' policy for non-violent crimes.

     


    From the Scout Report on May 7, 2004

    World Bank: Anticorruption ---  http://www1.worldbank.org/publicsector/anticorrupt/index.cfm

    In its many different guises, corruption around the world tends to affect the poor, who are often the most reliant on the provision of public services, and are also least likely to be able to pay the extra costs associated with bribery and fraud. The World Bank has identified corruption as "the single greatest obstacle to economic and social development," and thusly has set up this anticorruption website to serve as an online resource for policy-makers, non-governmental organizations (NGOs), and other interested parties. On the site, the World Bank lays out its strategy for combating corruption, which includes increasing political accountability, strengthening civil society participation, and improving public sector management. The site also contains a number of helpful resources, such as toolkits for assessing government performance in this area, and information and reports on various regional and country-based approaches to dealing with corruption. The site is rounded out by a calendar of events and key strategy documents, such as "Reforming Public Institutions and Strengthening Governance, A World Bank Strategy."


    Siemens to Pay $1.34 Billion in Bribery Settlement
    One major question spiraling out of all this is what roll Siemens' auditor, KPMG played in allowing all this to come to pass.
    The Daily Caveat, November 26, 2008 --- http://www.michaeldavidthomas.com/dailycaveat/labels/Siemens.html

    The American settlement includes a $350 million payment to the Securities and Exchange Commission to settle allegations of accounting rule violations, which Siemens neither admitted nor denied. Siemens falls under American jurisdiction because its shares are listed in New York. Siemens pleaded guilty to circumventing and failing to maintain adequate internal controls, a requirement of the antibribery law, and will pay $450 million to the Justice Department. Three Siemens subsidiaries also pleaded guilty to more specific charges.

    "Siemens to Pay $1.34 Billion in Bribery Settlement," by Carter Dougherty, The New York Times, December 15, 2008 --- http://www.nytimes.com/2008/12/16/business/worldbusiness/16siemens.html

    Siemens, the German engineering conglomerate, closed the book on Monday on wide-ranging criminal investigations in the United States and Germany by agreeing to pay a record $1.34 billion in fines to settle cases accusing it of bribery around the world.

    In Washington, Siemens’s general counsel, Peter Solmssen, signed an $800 million settlement with the Department of Justice and the Securities and Exchange Commission to end an inquiry into possible violations of the Foreign Corrupt Practices Act. The fine is, by a colossal margin, the largest ever imposed under the antibribery legislation, now 31 years old.

    Munich prosecutors, whose trailblazing work revealed the outlines of a huge system of slush funds and illegal payments, also announced a deal with Siemens that would cost the company 395 million euros , or $540 million.

    German authorities are still looking into potential wrongdoing by former Siemens employees that could result in criminal charges.

    Crucially, Siemens avoided either a guilty plea or a conviction for bribery, allowing it to maintain its status as a “responsible contractor” with the United States Defense Logistics Agency. Without this benchmark certification, Siemens could have been excluded from public procurement contracts in the United States and elsewhere. German authorities are preparing a similar certification.

    The fine in the United States was nearly 17 times more than the next-largest imposed for overseas commercial bribery. Yet it still represents victory for Siemens, because it is far below what might have been levied under the Justice Department’s guidelines.

    With $1.36 billion identified as potentially corrupt payments worldwide, a fine of up to $2.7 billion would have been possible. But American authorities said in court papers filed in Washington that they were impressed by the company’s efforts to identify wrongdoing and prevent new occurrences.

    “Compared to other cases that have been brought, we have been dealt with very fairly,” Mr. Solmssen of Siemens said in a telephone interview.

    The next-highest fine imposed by American authorities for bribery was $48 million, paid by the oil field services company Baker Hughes in 2007.

    Shares of Siemens, based in the southern German city of Munich, initially rallied on the news, which was lower than what investors had anticipated as settlement talks entered their final phase this autumn. But the shares later fell lower in Frankfurt, ending at 47.15 euros, down 23 euro cents. On the New York Stock Exchange, the American depository receipts of Siemens gained 55 cents, to $64.47.

    “Before Siemens started giving hints, we would have expected much more,” said Roland Pitz, an analyst at UniCredit in Munich. “The employees must be celebrating.”

    Gerhard Cromme, the Siemens chairman — who had to juggle the sudden departure of a chief executive as a result of the crisis, and a two-year distraction from its core business of manufacturing energy, medical and other industrial equipment, — allowed himself just a few smiles as he announced the deals in Munich.

    “Siemens is closing a painful chapter in its history,” Mr. Cromme said at a news conference.

    The American settlement includes a $350 million payment to the Securities and Exchange Commission to settle allegations of accounting rule violations, which Siemens neither admitted nor denied. Siemens falls under American jurisdiction because its shares are listed in New York.

    Siemens pleaded guilty to circumventing and failing to maintain adequate internal controls, a requirement of the antibribery law, and will pay $450 million to the Justice Department. Three Siemens subsidiaries also pleaded guilty to more specific charges.

    The Siemens approach was also striking for its alacrity. The Baker Hughes settlement took five years to reach, but Siemens, determined to end a persistent distraction to a new management team, pulled off a settlement in less than two.

    Munich prosecutors are still investigating former Siemens employees and say they have not ruled out criminal charges. So far, they have leveled only minor charges of failing to effectively supervise the company against two former chief executives, Heinrich von Pierer and Klaus Kleinfeld, which could result at most in fines.

    “This investigation will continue as planned and might take considerable time,” Christian Schmidt-Sommerfeld, the lead Munich prosecutor, said in a statement on Monday.

    But the company itself is no longer in danger of being charged.

    “We have wrapped up all of the potential claims against Siemens arising out of the alleged conduct in both countries,” Mr. Solmssen said.

    Continued in article

    Bob Jensen's threads on KPMG's litigation problems are at http://www.trinity.edu/rjensen/Fraud001.htm#KPMG

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

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

     


    How to funnel subsidies to a few politically connected

    October 29, 2007 message from David Cay Johnston [davidcay@mac.com]

    Professor Jensen,

    You have cited some of my work at your web pages and so I wanted to make you aware of my forthcoming book FREE LUNCH, which follows on the work in PERFECTLY LEGAL, a national best seller, winner of the Investigative Book of the Year award and widely used as a college text in accounting, business and law schools.

    FREE LUNCH examines money flows that would not be captured by following the flow of funds across government and corporate books. It shows entire industries that derive all of their profits from these subtle and sometimes hidden subsidies and how policies that supposedly opened markets to competition and "deregulated" thwarted the market, induced higher prices and funneled money from the many to the few. For example, I show how a single major company gets a half billion dollars a year in free labor which is delivered in a way that, unintentionally, benefits criminals.

    I hope you will take an interest in FREE LUNCH, which will be out Dec. 27, and consider it for your students.

    Allbests,

    David Cay Johnston Reporter The New York Times
    212.556.3605 office 585.473.8704 home office

    davidcay@nytimes.com 
    davidcay@mac.com 

    **********************************
    Free Lunch: How the Wealthiest Americans Enrich Themselves at Government Expense (and Stick You With the Bill) Coming Dec. 27 from Portfolio Books

    Perfectly Legal: The Covert Campaign to Rig Our Tax System to Benefit the Super Rich and Cheat Everybody Else NYTimes Bestseller 2004 Book of the Year medal awarded by Investigative Reporters & Editors (IRE)

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


    Topics for Class Debate

    This might be a good topic of debate for an ethics and/or fraud course.  The topic is essentially the problem of regulating and/or punishing many for the egregious actions of a few.  The best example is the major accounting firm of Andersen in which 84,000 mostly ethical and highly professional employees lost their jobs when the firm's leadership repeatedly failed to take action to prevent corrupt and/or incompetent audits of a small number audit partners.  Clearly the firm's management failed and deserves to be fired and/or jailed for obstruction of justice and failure to protect the public in general and 83,900 Andersen employees.  A former Andersen executive partner, Art Wyatt, contends that Andersen's leadership did not get the message and that leadership in today's leading CPA firms is still not getting the message --- http://aaahq.org/AM2003/WyattSpeech.pdf 

    Even better examples can be found in the likes of Merrill Lynch, Morgan Stanley, leading investment banks, leading insurance companies, and leading mutual funds that were Congress to the core but not necessarily on the edges where thousands of employees earned honest livings in ethical dedication to their professions.  Their new leaders still don't seem to be getting the message --- http://www.trinity.edu/rjensen/fraudCongress.htm 

    The problem is how to clean out the core without destroying all that is good in an organization.  Another side of the problem is how to protect the public from bad organizations filled with mostly honest employees.

    Most of us view The Wall Street Journal (WSJ) as a good source for reporting on financial and accounting fraud and scandal.  By "reporting" I mean that WSJ reporters actually canvas the world and ferret out much of which later gets reported on TV networks (TV networks tend to rely on what newspapers like the WSJ actually discover).  But an editor of the WSJ actually stated to me one time that the WSJ is really two newspapers bundled into one.  The bulk of the paper is devoted to reporting.  But the Editorial Page is often devoted to defending the crooks that are scandalized on Page 1 of the WSJ.  My best example is the saga of felon Mike Milken who was constantly scandalized on Page 1 and defended on Page A14 (or wherever the Editorial Page happened to be that day).

    I tend to have a knee jerk reaction to get the bad guys or the incompetent guys who should never be put in charge.  But in fairness there is something to be said for using a hammer where a scalpel might do the job.  We have two hammers in the United States.  One is called government regulation.  The other is called tort litigation.  Both can badly injure the innocent along with the guilty.  We have one major scalpel that is very dull and almost never used properly.  That is punishment that deters white collar crime.  White collar crime pays in the United States.  The criminal generally gets away with the crime or gets a very light punishment before retiring in luxury from the take of his or her crime.  In the meantime the crook's honest colleagues like the many employees of Andersen and Enron take the fall.  For my complaints about leniency and white collar crime see http://www.trinity.edu/rjensen/FraudConclusion.htm#CrimePays 

    Now the top crime fighters (Donaldson and Spitzer) in the U.S., who I think are well intended, are taking the heat from Page A14 of the WSJ while Page 1 of the WSJ thinks they are often citing them for their good works.  

    And let's not forget the class of gutless wonders, who were incompetent in their jobs while leading government regulatory agencies, and are now raking in millions because of their prior incompetence.  Does the name Arthur Levitt ring a bell? 
    Hint:  He headed up the SEC in the 1990s when the worst corporate, mutual fund, investment banking, and insurance scams raking in billions of dollars were taking place right under his nose.  

    "Mutual Displeasure," Editorial, The Wall Street Journal,  January 17, 2005; Page A14 --- http://online.wsj.com/article/0,,SB110591631511827345,00.html?mod=todays_us_opinion 

    The Washington rumor mill has it that SEC Chairman William Donaldson is fighting for his job after a checkered two-year tenure. Whatever the merits of that gossip, Mr. Donaldson has been handed a golden opportunity to both exert some intellectual leadership and quiet his critics by reconsidering the agency's rule on mutual fund "independence."

    That step, we'd add, would also help restore some SEC credibility. No one denies the recent corporate scandals deserved a tough response, and the federal prosecution of individual offenders has usually hit the right targets. Far less thoughtful has been the Donaldson SEC's habit of punishing business as a class, especially with broad new rules that seem designed mainly to keep up with New York Attorney General Eliot Spitzer. An agency once admired for thoroughness has become known for its slapdash rule-making -- from shareholder access to hedge funds to stock-exchange regulation.

    The mutual fund "reform" of last summer is a case in point. Red-faced that Mr. Spitzer exposed the late-trading offenses, the SEC rushed to show its relevance with a regulation requiring that 75% of all mutual fund board directors be "independent," including the chairman. What this means in practice is that folks like Edward Johnson, who has run Fidelity Investments for three decades without scandal and whose reputation has helped to attract investors, now must step aside.

    Of hundreds of funds managing $7.5 trillion in assets, some 80% have chairmen from management, while about half fail the 75% "independent" standard. The process of identifying, recruiting and appointing independent members will not only be costly but will divert resources away from more profitable uses. The independent directors of one small fund ($218 million assets) estimate compliance with just the 75% independent director rule would cost its shareholders an average of $20,000 a year.

    The requirement is so arbitrary that Congress has asked the SEC to justify its actions, while the U.S. Chamber of Commerce is suing to have it thrown out. And with good cause. The SEC may not even have the authority under the 1940 Investment Company Act to require corporate governance standards -- and the agency knows it. That's why, rather than mandate the requirements straight out, it instead made the industry's continued use of certain standard regulatory exemptions (which the SEC does have power to grant) contingent on adopting the new requirements.

    Under the 1940 Act that established mutual fund standards, Congress considered and rejected a requirement that even a simple majority of the fund's directors be independent. Congressional testimony at the time noted that many investors were "buying" the management of a particular person, and that they wouldn't be served by a board that constantly overrode that person's decisions.

    Now, it's possible to argue that new times call for new ways to make boards more accountable. Yet the SEC didn't even try. Agencies have an obligation to examine what new rules mean for competition and capital formation, and when the mutual fund rule got rolling Republican Commissioner Cynthia Glassman called for economic analysis of independent- vs. management-chaired funds, as well as of the rule's costs. Mr. Donaldson claimed he too wanted more info.

    No report was ever done. Mr. Donaldson ignored research that did exist, in particular a Fidelity-sponsored study showing that fund companies with independent chairmen have worse investment performance. "There are no empirical studies that are worth much," he pronounced when he and the two Democratic Commissioners approved the rule by 3-2 vote in June. "You can do anything you want with numbers." Well, yes, as the SEC vote showed.

    The process was such a stinker that the two other GOP SEC Commissioners filed a rare official dissent. They noted the rule was arbitrary (why 75%?) and failed to consider less onerous alternatives, and they bemoaned the lack of analysis. The SEC had acted by "regulatory fiat" and "simply to appear proactive." Ouch.

    Led by New Hampshire Senator Judd Gregg, Congress has passed legislation demanding the SEC submit a report to Congress by May showing a "justification" for the new rule, including whether independent boards perform better or have lower expenses. But the SEC is so far giving Congress the back of its hand and last week rejected a U.S. Chamber request to delay the rule's imposition.

    What's really going on here is that an SEC regulatory staff that failed in its earlier mutual-fund oversight now wants to punish the law-abiding as well as the guilty. This is unnecessary, but it's also unfair. Far from being an embarrassing turnaround, a reassessment is a chance for Mr. Donaldson to prove that both he and his agency are more interested in getting things right, than simply getting things done.

    I might point out that my take on this is that Page A14 of the WSJ  is part and parcel to the establishment on Wall Street and Page 1 of the WSJ is written by reporters who are more concerned with discouraging egregious fraud and incompetence.

     

    Chartered Jets, a Wedding At Versailles and Fast Cars To Help Forget Bad Times.
    As financial companies start to pay out big bonuses for 2003, lavish spending by Wall Streeters is showing signs of a comeback. Chartered jets and hot wheels head a list of indulgences sparked by the recent bull market.
    Gregory Zuckerman and Cassell Bryan-Low, "With the Market Up, Wall Street High Life Bounces Back, Too," The Wall Street Journal, February 4, 2004 --- http://online.wsj.com/article/0,,SB107584886617919763,00.html?mod=home%5Fpage%5Fone%5Fus 

    "How Hazards for Investors Get Tolerated Year After Year." by Susan Pulliam, Susanne Craig, and Randal Smith, The Wall Street Journal, February 6, 2004 --- Scroll down at http://www.trinity.edu/rjensen/FraudConclusion.htm#Debate 

    "OVERCOMPENSATING In Fraud Cases Guilt Can Be Skin Deep," by Alex Berenson, The New York Times, February 29, 2004 --- Scroll down at http://www.trinity.edu/rjensen/FraudConclusion.htm#Debate 


    Labor Unions Want Less Financial Disclosure and accountability

    From day one of the Obama era, union leaders want the lights dimmed on how they spend their mandatory member dues. The AFL-CIO's representative on the Obama transition team for Labor is Deborah Greenfield, and we're told her first inspection stop was the Office of Labor-Management Standards, or OLMS, which monitors union compliance with federal law. Ms. Greenfield declined to comment, citing Obama transition rules, but her mission is clear enough. The AFL-CIO's formal "recommendations" to the Obama team call for the realignment of "the allocation of budgetary resources" from OLMS to other Labor agencies. The Secretary should "temporarily stay all financial reporting regulations that have not gone into effect," and "revise or rescind the onerous and unreasonable new requirements," such as the LM-2 and T-1 reporting forms. The explicit goal is to "restore the Department of Labor to its mission and role of advocating for, protecting and advancing the interests of workers." In other words, while transparency is fine for business, unions are demanding a pass for themselves.
    "Quantum of Solis Big labor wants Obama to dilute union disclosure rules," The Wall Street Journal, December 21, 2008 --- http://online.wsj.com/article/SB122990431323225179.html?mod=djemEditorialPage


    Question
    Are many share repurchases motivated more out of executive greed than shareholder benefits?
    In accounting classes, it might be stressed that increased executive compensation is one of the incentives of buying treasury stock.

    "Controlled by the corporations:  Before we can deal with a financial crisis manufactured in boardrooms, we must curb corporate power over our legislators," by Prem Sikka, The Guardian, January 8, 2008 --- http://www.guardian.co.uk/commentisfree/2009/jan/08/financial-crisis-regulation

    Repurchase of shares has the potential to enable company executives to make huge profits. A simple example would help to illustrate the point. Suppose a company has earnings of £100 and 100 shares. Now the earnings per share are £1. Suppose the company decides to use its surplus cash to buy back 50 shares. After repurchase, it has only 50 shares in circulation. So the earnings per share (EPS) are now £2. The significance of this is that many executive remuneration schemes link profits to EPS. Without creating an iota of additional wealth, directors can increase earnings per share, their bonuses and share options. The company pays out real cash to buy back its shares. Such cash could have been used to bolster capital, liquidity or research and development, or could even have been put away for a rainy day. In some cases, companies have taken on extra debts to buy back their own shares, which opens them up to higher interest charges and vulnerability. Of course, there is the forlorn hope that the reduction in the number of shares might make the remaining shares somehow more marketable, or that the repurchase of shares might assure markets and push up the share price.

    One US
    study estimated that about 100 companies a month were buying back their shares. Nearer home, Alliance & Leicester announced a £300m share buyback at nearly £12 a share. Soon afterwards it was rescued by Banco Santander at just £3.17 a share. HBOS had a £750m share buyback programme and has now been bailed out by the UK taxpayer. Barclays bought back 2m shares at 451p. In recent weeks, its share price has been about a third of that and the bank had to raise additional money from Middle East investors. Northern Rock also has a history of buying back its shares and had to be bailed out by the taxpayer as well.

    Continued in article


    Women of Wall Street Get Their Day in Court

    "The Women of Wall Street Get Their Day in Court," by Patrick McGeehan, The New York Times, July 11, 2004 --- http://www.nytimes.com/2004/07/11/business/yourmoney/11wall.html 

    Before Eliot Spitzer, the crusading attorney general of New York, became their main adversary, the firms were at war with large numbers of their own employees - specifically, women who had worked for them and, in some cases, still did. In 1996 and 1997, lawsuits against Merrill Lynch and Smith Barney cracked open a Pandora's box of complaints from female brokers about hostile and unfair environments they said they found at brokerage offices. Settling those suits has cost the firms more than $100 million.

    Now, as they work to repair the self-inflicted damage to their reputations from the stock-analyst scandals of the last few years, Wall Street firms are girding for another round of attacks on their treatment of women.

    The main event of the summer will be the trial in the federal government's discrimination suit against Morgan Stanley. The jury was selected on Friday afternoon.

    In an opening argument scheduled to be heard tomorrow by Judge Richard M. Berman in United States District Court in Manhattan, a lawyer for the Equal Employment Opportunity Commission is expected to tell jurors that Morgan Stanley allowed managers and employees in one unit of its investment bank to mistreat their female colleagues, pay them less and promote them more slowly and less often than men. More than two dozen women who have worked there are expected to recount incidents of what they said was sexual harassment, including lurid details about their colleagues' entertaining clients at strip clubs.

    Continued in the article

    Frank Partnoy wrote about sexual degeneracy on Wall Street in his various books. (See below)


     

    Derivative Financial Instruments Frauds

    "How Do Auditors Use Valuation Specialists When Auditing Fair Values?" by Emily E. Griffith, SSRN, May 30, 2014 ---
    http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2460970 

    Abstract:
    Auditors frequently rely on valuation specialists in audits of fair values to help them improve audit quality in this challenging area. However, auditing standards provide inadequate guidance in this setting, and problems related to specialists’ involvement suggest specialists do not always improve audit quality. This study examines how auditors use valuation specialists in auditing fair values and how specialists’ involvement affects audit quality. I interviewed 28 audit partners and managers with extensive experience using valuation specialists and analyzed the interviews from the perspective of Giddens’ (1990, 1991) theory of trust in expert systems. I find that while valuation specialists perform many of the most difficult and important elements of auditing fair values, auditors retain the final responsibility for making overall conclusions about fair values. This situation causes tension for auditors who bear responsibility for the final conclusions about fair values, yet who must rely on the expertise of valuation specialists to make their final judgments. Consistent with this tension, auditors tend to make specialists’ work conform to the audit team’s prevailing view. This puts audit quality at risk. Additional threats to audit quality arise from the division of labor between auditors and valuation specialists because auditors, though ultimately responsible for audit judgments, must rely on work done by valuation specialists that they cannot understand or review in the depth that they review other audit work papers. This study informs future research addressing problems related to auditors’ use of valuation specialists, an area in which problems have already been identified by the PCAOB and prior research
    .

    Jensen Comment 1
    One of the problems is that some types of valuation may rely upon the same defective databases no matter whether they are used by employees of audit firms or outsourced valuation specialists hired by audit firms.Exhibit A is that virtually all valuation experts of interest rate swaps and forward contracts using the LIBOR underlying were relying upon LIBOR yeild curves in the Bloomberg or Reuters database terminals that were using LIBOR rates manipulated fraudulently by the large banks like Barclays ---
    http://en.wikipedia.org/wiki/Libor

    On 28 February 2012, it was revealed that the U.S. Department of Justice was conducting a criminal investigation into Libor abuse.[49] Among the abuses being investigated were the possibility that traders were in direct communication with bankers before the rates were set, thus allowing them an advantage in predicting that day's fixing. Libor underpins approximately $350 trillion in derivatives. One trader's messages indicated that for each basis point (0.01%) that Libor was moved, those involved could net "about a couple of million dollars".[50]

    On 27 June 2012, Barclays Bank was fined $200m by the Commodity Futures Trading Commission,[7] $160m by the United States Department of Justice[8] and £59.5m by the Financial Services Authority[9] for attempted manipulation of the Libor and Euribor rates.[51] The United States Department of Justice and Barclays officially agreed that "the manipulation of the submissions affected the fixed rates on some occasions".[52][53] On 2 July 2012, Marcus Agius, chairman of Barclays, resigned from the position following the interest rate rigging scandal.[54] Bob Diamond, the chief executive officer of Barclays, resigned on 3 July 2012. Marcus Agius will fill his post until a replacement is found.[55][56] Jerry del Missier, Chief Operating Officer of Barclays, also resigned, as a casualty of the scandal. Del Missier subsequently admitted that he had instructed his subordinates to submit falsified LIBORs to the British Bankers Association.[57]

    By 4 July 2012 the breadth of the scandal was evident and became the topic of analysis on news and financial programs that attempted to explain the importance of the scandal.[58] On 6 July, it was announced that the U.K. Serious Fraud Office had also opened a criminal investigation into the attempted manipulation of interest rates.[59]

    On 4 October 2012, Republican U.S. Senators Chuck Grassley and Mark Kirk announced that they were investigating Treasury Secretary Tim Geithner for complicity with the rate manipulation scandal. They accused Geithner of knowledge of the rate-fixing, and inaction which contributed to litigation that "threatens to clog our courts with multi-billion dollar class action lawsuits" alleging that the manipulated rates harmed state, municipal and local governments. The senators said that an American-based interest rate index is a better alternative which they would take steps towards creating.[60] Aftermath

    Early estimates are that the rate manipulation scandal cost U.S. states, counties, and local governments at least $6 billion in fraudulent interest payments, above $4 billion that state and local governments have already had to spend to unwind their positions exposed to rate manipulation.[61] An increasingly smaller set of banks are participating in setting the LIBOR, calling into question its future as a benchmark standard, but without any viable alternative to replace

    Jensen Comment 2
    FAS 133 and IAS 39 ushered in national and international requirements to book derivative contracts at fair values and adjust those values to "market" at least every 90 days. However, those "markets" are replete with market manipulation scandals that corrupt the databases used by valuation experts---
    Scroll Down Deeply Below

    A very concise summary of the positions of various accounting theory experts in history since 1909 and authoritative bodies over the years since 1936:
    "Asset valuation: An historical perspective"
    Authors: Racliffe, Thomas A. (Thomas Arthur) and Munter, Paul
    Accounting Historians Journal
    1980
    http://umiss.lib.olemiss.edu:82/record=b1000230
    Jensen Comment:  I really liked this summary of the valuation literature prior to 1980.
    For example, what was the main difference between exit value advocates Chambers versus Sterling?

    Bob Jensen's threads on fair value accounting --- http://www.trinity.edu/rjensen/Theory02.htm#FairValue


    "The Origins of Derivative Instruments," by Stephen G. Cecchetti, Brandeis University ---
    http://people.brandeis.edu/~cecchett/Textbook%20inserts/The%20Origin%20of%20Derivatives.htm

    In financial markets, the term "derivatives" is used to refer to a group of instruments that derive their value from some underlying commodity or market.   Forwards, futures, swaps and options are all types of derivative instruments and are widely used for hedging or speculative purposes.   While trading in derivative products has grown tremendously in recent times, early evidence of these types of instruments can be traced back to ancient Greece.   Aristotle related a story about how the Greek philosopher Thalus profited handsomely from an option-type agreement around the 6th century b.c.   According to the story, one-year ahead, Thalus forecast the next olive harvest would be an exceptionally good one.   As a poor philosopher, he did not have many financial resources at hand. But he used what he had to place a deposit on the local olive presses.   As nobody knew for certain whether the harvest would be good or bad, Thalus secured the rights to the presses at a relatively low rate.   When the harvest proved to be bountiful, and so demand for the presses was high, Thalus charged a high price for their use and reaped a considerable profit.

    A critical attribute of Thalus?s arrangement was the fact that its merit did not depend on his forecast for a good harvest being accurate.   The deposit gave him the right but not the obligation to hire the presses.   If the harvest had failed, his losses were limited to the initial deposit he paid.   Thalus had purchased an option.

    There is evidence that the use of a type of forward contract was prevalent among merchants in medieval European trade fairs. When trade began to flourish in the 12th century merchants created a forward contract called a lettre de faire (letter of the fair).   These letters allowed merchants to trade on the basis of a sample of their goods, thus relieving them of the need to transport large quantities of merchandise along dangerous routes with no guarantee of a buyer at the journey?s end.   The letter acted as evidence that the full consignment of the specified commodity was being held at a warehouse for future delivery.   Eventually, the contracts themselves were traded among the merchants.  

    The first record of organized trading in futures comes from 17th century Japan.   Feudal Japanese landlords would ship surplus rice to storage warehouses in the cities and then issue tickets promising future delivery of the rice.   The tickets represented the right to take delivery of a certain quantity of rice at a future date at a specified price.  These rice tickets were traded on the Dojima rice market near Osaka and in 1730.   Trading in rice tickets allowed landlords and merchants to lock the prices at which rice was bought and sold, reducing the risk they faced. The tickets also provided flexibility.  Someone holding a rice ticket but not a holder of a rice ticket but not wanting to take delivery could sell it in the market. The rules governing the trading on the Dojima market were similar to those of modern-day futures markets.

    Moving forward 200 years, Chicago was central to the 19th century development of futures contracts in the US.   As in Japan, the seasonal nature of agricultural production was the main impetus behind the development of these financial instruments.   Farmers would traditionally bring their harvest to market once a year in search of buyers creating a seasonal glut and driving prices to extremely low levels.   At other times of year, shortages would emerge in the urban areas driving prices to extremely high levels.   This cycle was compounded by the fact that storage facilities in the cities were inadequate and transportation from rural areas was difficult.

    In the early 1800s, forward arrangements began to appear to deal with the risk caused by market volatility.   These were known as ?to arrive? contracts and involved an agreement between a buyer and seller for the future delivery of grain.   The quantity and grade of the grain would be specified as well as the delivery date, as well an agreed-upon price.   Soon the contracts themselves began to be traded in anticipation of changes in the market price of grain.   With increases in trading volume increased came a realization of the benefits of standardization and the need for an organized exchange.  The result, in 1848, was the founding of the Chicago Board of Trade.   Other early exchanges involved in futures trading in the US included the New York Cotton Exchange, established in 1870, and the New York Coffee Exchange, set up in 1885

    Various events in the early 1970s conspired to spur the development of modern derivatives markets. There was the collapse of the fixed-exchange rate system provided the impetus for the trading of foreign-exchange derivatives; while the theoretical advances of Black and Scholes allowed traders to compute the price of options so they could buy and sell them.  The first financial futures, seven foreign currency contracts, were traded on the Chicago Mercantile Exchange in 1972, while the first swap agreements were executed by the Salomon Brothers in London in 1981.   Equity derivatives, based on underlying stock indices, began to emerge in the late 1980?s.   Today, derivative instruments based on a wide range of underlying markets are traded globally and complex "exotic" products can be built to hedge or assume almost any type of risk imaginable.

     

    March 21, 2010 message from Mac Wright [Mac.Wright@VU.EDU.AU]

    May I recommend "Lorimer G.H. "Letters of a self made merchant to his son" (I do not remember the original publisher ) 1895.

    That book contained some astute observations about hedging and speculating.

    Kind regards,

    Mac Wright
    Co-ordinator Aviation Program Victoria University Melbourne Australia

     

    Definition from Wikipedia

    Derivatives are financial instruments whose value changes in response to the changes in underlying variables. The main types of derivatives are futures, forwards, options, and swaps.

    The main use of derivatives is to reduce risk for one party. The diverse range of potential underlying assets and pay-off alternatives leads to a huge range of derivatives contracts available to be traded in the market. Derivatives can be based on different types of assets such as commodities, equities (stocks), bonds, interest rates, exchange rates, or indexes (such as a stock market index, consumer price index (CPI) — see inflation derivatives — or even an index of weather conditions, or other derivatives). Their performance can determine both the amount and the timing of the pay-offs.

    Insurance and Hedging

    One use of derivatives is as a tool to transfer risk by taking the opposite position in the futures market against the underlying commodity. For example, a wheat farmer and a wheat miller could enter into a futures contract to exchange cash for wheat in the future. Both parties have reduced the risk of the future: the uncertainty of the price and the availability of wheat.

    Speculation and arbitrage

    Speculators may trade with other speculators as well as with hedgers. In most financial derivatives markets, the value of speculative trading is far higher than the value of true hedge trading. As well as outright speculation, derivatives traders may also look for arbitrage opportunities between different derivatives on identical or closely related underlying securities.

    In addition to directional plays (i.e. simply betting on the direction of the underlying security), speculators can use derivatives to place bets on the volatility of the underlying security. This technique is commonly used when speculating with traded options. Speculative trading in derivatives gained a great deal of notoriety in 1995 when Nick Leeson, a trader at Barings Bank, made poor and unauthorized investments in index futures. Through a combination of poor judgement on his part, lack of oversight by management, a naive regulatory environment and unfortunate outside events like the Kobe earthquake, Leeson incurred a $1.3 billion loss that bankrupted the centuries-old financial institution.

    Bob Jensen's Definition --- http://www.trinity.edu/rjensen/acct5341/speakers/133glosf.htm#Derivative

    Derivative =

    A financial instrument whose value is derived from changes in the value of some underlying asset such as a commodity, a share of stock, a debt instrument, or a unit of currency.  A nice review appears in Myron Scholes' Nobel lecture that is reprinted as "Derivatives in a Dynamic Environment," American Economic Review, June 1998, 350-370.  For further elaboration, see derivative financial instrument.    Especially note the terms hedge and disclosure.

    Humor:  "The Idiot's Guide to Hedging and Derivatives" ---  http://www.trinity.edu/rjensen/fraud033103.htm#Idiot'sGuide 

    Also see CBOE, CBOT, and CME derivative exchange markets for some great tutorials on derivatives investing and hedging.

    Derivative Financial Instrument = = 

    a financial instrument that by its terms, at inception or upon the occurrence of a specified event, provides the holder (or writer) with the right (or obligation) to participate in some or all of the price changes of an underlying (that is, one or more referenced financial instruments, commodities, or other assets, or other specific items to which a rate, an index of prices, or another market indicator is applied) and does not require that the holder or writer own or deliver the underlying.  A contract that requires ownership or delivery of the underlying is a derivative financial instrument if (a) the underlying is another derivative, (b) a mechanism exists in the market (such as an organized exchange) to enter into a closing contract with only a net cash settlement, or (c) the contract is customarily settled with only a net cash payment based on changes in the price of the underlying.  What is most noteworthy about derivative financial instruments is that in the past two decades, the global use of derivatives has exploded exponentially to where the trading in notional amounts is in trillions of dollars.  Unlike FAS 133, IAS 39 makes explicit reference also to an insurance index or catastrophe loss index and a climatic or geological condition. Also IAS 39 does not require net settlement.

    The FASB's Derivatives and Hedging Glossary (in the Accounting Standards Codification Database) ---
    http://asc.fasb.org/subtopic&trid=2229141&nav_type=left_nav


    Free derivative financial instruments document from Ira Kawaller --- http://www.kawaller.com/

    "10 Tenets of Derivatives" (loads very slow) --- http://www.kawaller.com/pdf/AFP_10Tenets.pdf 

    Bob Jensen's tutorials on accounting for derivative financial instruments --- http://www.trinity.edu/rjensen/caseans/000index.htm


    Paragraph 6 of FAS 133 reads as follows:

    . A derivative instrument is a financial instrument or other contract with all three of the following characteristics:
     

    a. It has (1) one or more underlyings and (2) one or more notional amounts or payment provisions or both. Those terms determine the amount of the settlement or
    settlements, and, in some cases, whether or not a settlement is required. \1/\2/

    ==========================================================================

    \1/ Sometimes other names are used. For example, the notional amount is called a face amount in some contracts.

    \2/ The terms underlying, notional amount, payment provision, and settlement are intended to include the plural forms in the remainder of this Statement. Including both the
    singular and plural forms used in this paragraph is more accurate but much more awkward and impairs the readability.

    ==========================================================================

    b. It requires no initial net investment or an initial net investment that is smaller than would be required for other
    types of contracts that would be expected to have a similar response to changes in market factors.

    c. Its terms require or permit net settlement, it can readily be settled net by a means outside the contract, or it provides for delivery of an asset that puts the recipient
    in a position not substantially different from net settlement.
     

    Most derivatives like forward, futures, and swap contracts are acquired at zero cost such that historical cost accounting is meaningless.  The exception is a purchased/written option where a small premium is paid/received to buy/sell the option.  Thus if the derivative financial instrument contract is defaulted a few minutes after being transacted there are generally zero or very small damages.  Such is not the case with traditional non-derivative financial instruments like bonds where the entire notional amounts (thousands or millions of dollars) change hands initially such that enormous damages are possible immediately after the notional amounts change hands.  In the case of of a derivative contract, the notional does not change hands.  It is only used to compute a contracted payment such as a swap payment.

    For example, in the year 2004 Wells Fargo Bank sold $63 million in bonds with an interest rate "derived" from the price of a casino's common stock price.  The interest payments are "derivatives" in one sense, but the bonds are not derivative financial instruments scoped into FAS 133 due to Condition b in Paragraph 6 quoted above.  In the case of bonds, the bond holders made a $63 million initial investment of the entire notional amount.  If Wells Fargo also entered into an interest rate swap to lock in a fixed interest rate, the swap contract would be a derivative financial instrument subject to FAS 133.  However, the bonds are not derivative financial instruments under FAS 133 definitions.


    New in Paperback!
    GLOBAL DERIVATIVE DEBACLES --- http://www.worldscibooks.com/economics/7141.html 
    From Theory to Malpractice
    by Laurent L Jacque (Tufts University, USA & HEC School of Management, France)

    336pp
    978-981-4366-19-9(pbk): US$29 / £19   US$20.30 / £13.30
    978-981-283-770-7: US$54 / £36   US$37.80 / £25.20
    978-981-283-771-4(ebook): US$70   US$49

    Table of Contents (80k)
    Preface (61k)
    Chapter 1: Derivatives and the Wealth of Nations (173k)

    Contents:

    • Derivatives and the Wealth of Nations
    • Forwards:
      • Showa Shell Sekiyu K K
      • Citibank's Forex Losses
      • Bank Negara Malaysia
    • Futures:
      • Amaranth Advisors LLC
      • Metallgesellschaft
      • Sumitomo
    • Options:
      • Allied Lyons
      • Allied Irish Banks
      • Barings
      • Société Générale
    • Swaps:
      • Procter and Gamble
      • Gibson Greeting Cards
      • Orange County
      • Long-Term Capital Management
      • AIG
      • From Theory to Malpractice: Lessons Learned

     


    "Volcker and Derivatives:  The end game for financial reform," The Wall Street Journal, June 24, 2010 ---
    http://online.wsj.com/article/SB10001424052748704853404575323032606552688.html 

    Financial reform in the hands of a Democratic Congress is looking eerily similar to health-care reform: Public skepticism is proving to be no brake on the liberal ambitions, and substance is increasingly divorced from the problems Washington claims to be solving.

    The bill emerging from House-Senate conference seems less concerned with preventing future bank bailouts than with preventing future bank profits. And if some Main Street companies suffer collateral damage in the drive to reduce Wall Street's over-the-counter derivatives trading, Democrats appear to view them as acceptable casualties.

    As early as today, House and Senate negotiators may agree on a Volcker Rule, limiting the risks big banks can take in trading for their own account, as well as a separate set of rules regulating the derivatives trades banks can do on behalf of clients. America doesn't need both.

    A Volcker Rule won't be easy to implement but it makes policy sense: limit the opportunities for banks to speculate with federally insured deposits. Combined with high capital standards, this won't lead to perfect outcomes—we're talking about regulation, after all—but it would once again draw a risk-taking line that was crossed too often in 2008.

    The other new rules, however, could harm taxpayers and commercial customers more than banks. For taxpayers, the danger comes from Senate plans to force much of the derivatives market through too-big-to-fail clearinghouses. Lead Senate negotiator Chris Dodd has backed a plan to explicitly give these clearinghouses taxpayer assistance in the event they face a liquidity crisis.

    The other dangerous idea is to force commercial companies to post additional margin even if they do not speculate but are simply using derivatives to hedge legitimate risks. A recent Business Roundtable survey finds that 90% of large corporations use derivatives and that the average firm would have to tie up 15% of the cash on its balance sheet if subjected to the new margin requirements.

    To take one example, Caterpillar might pay a bank to assume the risk of currency fluctuations in foreign markets so that it can focus on making bulldozers. It's possible that, depending on the movements of the dollar against foreign currencies, such a contract will ultimately require Caterpillar to pay more to the bank. Forcing banks to demand more cash up front from such companies is like saying regulators should approve every loan a bank makes, and review every single decision to extend credit.

    The theory that derivatives caused the financial crisis also continues to take a beating, most recently from regulation cheerleader Elizabeth Warren. The Troubled Asset Relief Program's Congressional overseer recently put out a report on the government's 2008 seizure of AIG. While the report has its flaws, Ms. Warren explodes the myth that the entire problem at AIG was caused by its credit-default-swap contracts. She explains that it was the housing bets, many of which were made without using CDS, that brought AIG to the brink of collapse.

    The message to Congress is to take Volcker but pass on punishing derivatives. Which means we'll probably get the opposite.

    Jensen Comment
    I personally don't agree with the above editorial position of regulation of derivatives. I think derivatives markets should be regulated along the lines recommended by my hero Frank Partnoy ---
    http://www.trinity.edu/rjensen/FraudRotten.htm#DerivativesFrauds

    GLOBAL DERIVATIVE DEBACLES: From Theory to Malpractice --- 
    http://www.worldscibooks.com/economics/7141.html 
    by Laurent L Jacque (Tufts University, USA & HEC School of Management, France) 
    World Scientific Books, ISBN: 978-981-283-770-7, 628pp 
    978-981-281-853-9: US$54 / £36   US$40.50 / £27 
    Table of Contents (44k) --- http://www.worldscibooks.com/etextbook/7141/7141_toc.pdf 
    Preface (27k)--- http://www.worldscibooks.com/etextbook/7141/7141_preface.pdf  
    Chapter 1: Derivatives and the Wealth of Nations (133k) --- 
    http://www.worldscibooks.com/etextbook/7141/7141_preface.pdf 
    Contents:
    • Derivatives and the Wealth of Nations --- http://www.worldscibooks.com/etextbook/7141/7141_preface.pdf
    • Forwards:
      • Showa Shell Sekiyu K K
      • Citibank's Forex Losses
      • Bank Negara Malaysia
    • Futures:
      • Amaranth Advisors LLC
      • Metallgesellschaft
      • Sumitomo
    • Options:
      • Allied Lyons
      • Allied Irish Banks
      • Barings
      • Société Générale
    • Swaps:
      • Procter and Gamble
      • Gibson Greeting Cards
      • Orange County
      • Long-Term Capital Management
      • AIG
      • From Theory to Malpractice: Lessons Learned

    Jensen Comment
    This book is weak on derivatives accounting but stronger on economics, finance, and law.
    Chapter 1 has a short summary of ancient history.

    Bob Jensen's threads and timeline on the history of derivatives instruments scandals and frauds ---
    http://www.trinity.edu/rjensen/FraudRotten.htm#DerivativesFrauds


    Mr. Buffett, who has interests in both companies, claimed there was another agenda (aside from hedging with derivatives). “The reason many of them do it (invest in derivative contracts) is that they want to smooth earnings,” he said, referring to the idea of trying to make quarterly numbers less volatile. “And I’m not saying there’s anything wrong with that, but that is the motivation.”
    "Derivatives, as Accused by Buffett," by Andrew Ross Sorkin, The New York Times, March 14, 2011 ---
    http://dealbook.nytimes.com/2011/03/14/derivatives-as-accused-by-buffett/?ref=business

    Mr. Buffett once described derivatives as “financial weapons of mass destruction.” Yet some of his most ardent fans have quietly raised eyebrows at his pontifications, given that he plays in the opaque market. In the fourth quarter alone, Berkshire made $222 million on derivatives. TheStreet.com published a column last spring with the headline: “Warren Buffett Is a Hypocrite.”

    ¶His comments, which were released last month by the financial crisis commission, come as the government is writing rules for derivatives as part of the Dodd-Frank financial regulatory overhaul. And the statements could influence the debate.

    ¶Mr. Buffett appeared to backpedal from his oft-quoted line, explaining: “I don’t think they’re evil per se. It’s just, they, I mean there’s nothing wrong with having a futures contract or something of the sort. But they do let people engage in massive mischief.”

    ¶The problems arise, Mr. Buffett said, when a bank’s exposure to derivatives balloons to grand proportions and uninformed investors start using them.

    ¶It “doesn’t make much difference if it’s, you know, one guy rolling dice against another, and they’re doing $5 a throw. But it makes a lot of difference when you get into big numbers.”

    ¶What worries him most is the big financial institutions that have millions of contracts. “If I look at JPMorgan, I see two trillion in receivables, two trillion in payables, a trillion and seven netted off on each side and $300 billion remaining, maybe $200 billion collateralized,” he said, walking through his thinking. “That’s all fine. But I don’t know what discontinuities are going to do to those numbers overnight if there’s a major nuclear, chemical or biological terrorist action that really is disruptive to the whole financial system.”

    ¶“Who the hell knows what happens to those numbers?” he asked. “I think it’s virtually unmanageable.”

    ¶Mr. Buffett defended Berkshire Hathaway’s use of derivatives, arguing that the company maintains a limited amount. At the time of the interview, the company had only about 250 derivative contracts. (It’s now down to 203.) “I want to know every contract, and I can do that with the way we’ve done it. But I can’t do it with 23,000 that a bunch of traders are putting on.”

    ¶He noted that when Berkshire bought General Re in 1998, the reinsurance company had 23,000 derivative contracts. “I could have hired 15 of the smartest people, you know, math majors, Ph.D.’s. I could have given them carte blanche to devise any reporting system that would enable me to get my mind around what exposure that I had, and it wouldn’t have worked,” he said to the government panel. “Can you imagine 23,000 contracts with 900 institutions all over the world with probably 200 of them names I can’t pronounce?” Berkshire decided to unwind the derivative deals, incurring some $400 million in losses.

    ¶Mr. Buffett said he used derivatives to capitalize on discrepancies in the market. (That’s what other investors must think they are doing — just not as successfully.)

    ¶Perhaps the most insightful nugget in the interview was Mr. Buffett’s explanation of why corporations use derivatives — and why they probably shouldn’t.

    ¶Many companies, as diverse as Coca-Cola and Burlington Northern, argue that they employ derivatives to hedge their risk.

    ¶The United States-based Coca-Cola tries to protect against fluctuations in currencies since it does business around the world. Burlington Northern, the railroad giant, uses the investments to limit the effect of fuel prices.

    ¶Mr. Buffett, who has interests in both companies, claimed there was another agenda. “The reason many of them do it is that they want to smooth earnings,” he said, referring to the idea of trying to make quarterly numbers less volatile. “And I’m not saying there’s anything wrong with that, but that is the motivation.”

    ¶The numbers all even out eventually, he cautioned, so derivatives don’t really make much difference in the long term.

    ¶“They’re going to lose as much on the diesel fuel contracts over time as they make,” he said of Burlington Northern. “I wouldn’t do it.”

    Continued in article

    March 16, 2011 reply from Kimberly Shanahan

    This is great reading - if you follow one of the links in the article, it shows you the transcript of Mr. Buffet's interview with the Financial Crisis Inquiry Commission. I had not seen it previously. Also, a great read.

    Thanks Bob for forwarding!

    Kimberly Shanahan

    Bob Jensen's threads on creative accounting, smoothing, and earnings management ---
    http://www.trinity.edu/rjensen/Theory02.htm#Manipulation

    Bob Jensen's tutorials on accounting for derivative financial instruments ---
    http://www.trinity.edu/rjensen/caseans/000index.htm

     


    While Frank Portnoy was fighting for more financial markets regulation, guess who was fighting against it tooth and nail?
    Few remember that Bill Clinton's administration, along with Greenspan and Levitt, fought successfully against regulation of financial markets.
    It's now Deja vu Larry Summers who is the liberal Keynesian scholar behind President Obama's economic recovery and budget spending.
    People remember Larry Summers as Harvard President who was forced out of office by feminists.
    But few remember that he was also Treasury Secretary during the presidency of Bill Clinton.
    Even fewer remember him as a virulent opponent of financial markets regulation.

    In 1997, Brooksley Born warned in congressional testimony that unregulated trading in derivatives could "threaten our regulated markets or, indeed, our economy without any federal agency knowing about it." Born called for greater transparency--disclosure of trades and reserves as a buffer against losses. Instead of heeding this oracle's warnings, Greenspan, Rubin & Summers rushed to silence her. As the Times story reveals, Born's wise warnings "incited fierce opposition" from Greenspan and Rubin who "concluded that merely discussing new rules threatened the derivatives market." Greenspan deployed condescension and told Born she didn't know what she doing and she'd cause a financial crisis . . . In early 1998, according to the Times story, one of the guys, Larry Summers, called Born to "chastise her for taking steps he said would lead to a financial crisis. But Born kept at it, unwilling to let arrogant men undermine her good judgment. But it got tougher out there. In June 1998, Greenspan, Rubin and the then head of the SEC, Arthur Levitt, Jr., called on Congress "to prevent Ms. Born from acting until more senior regulators developed their own recommendations." (Levitt now says he regrets that decision.) Months later, the huge hedge fund Long Term Capital Management nearly collapsed--confirming some of Born's warnings. (Bets on derivatives were a key reason.) "Despite that event," the Times reports, " Congress (apparently as a result of Greenspan & Summer's urging, influence-peddling and pressure) "froze" Born's Commissions' regulatory authority. The next year, Born left as head of the Commission.Born did not talk to the Times for their article. What emerges is a story of reckless, willful and arrogant action and behaviour designed to undermine a wise woman's good judgment. The three marketeers' disdain for modest regulation of new and risky financial instruments reveals a faith-based fundamentalist approach to the management of markets and risk. If there is any accountability left in our system, Greenspan, Rubin and Summers should not be telling anyone how to run anything. Instead, Barack Obama might do well to bring back Brooksley Born and promote to his team economists who haven't contributed to the ugly mess we're in.
    Katrina vanden Heuvel, "The Woman Greenspan, Rubin & Summers Silenced," The Nation, October 9, 2008 ---
    http://www.thenation.com/blogs/edcut/370925/the_woman_greenspan_rubin_summers_silenced

    Link forwarded by Jagdish Gangolly

    Rubin, Fed chairman Alan Greenspan and Summers were concerned that even a hint of regulation would send all the derivatives trading overseas, costing America business. Summers bluntly insisted that Born drop her proposal, says Greenberger.
    "The Reeducation of Larry Summers:  He's become a champion of massive government intervention in the economy, and he's even learning how to play nice. ," by Michael Hirsh and Evan Thomas, Newsweek Magazine, March 2, 2009 --- http://www.newsweek.com/id/185934

    Larry Summers had the rumpled, slightly sleepy look of a professor who has been up all night solving equations. President Obama's top economic adviser, the man mainly in charge of the immense government bailout, splayed himself on a sofa in the Roosevelt Room in the White House, beneath a portrait of Franklin Roosevelt, and did his best to be patient with two NEWSWEEK reporters. They were asking him to explain how he had changed—reeducated himself—since the freewheeling days of the late 1990s, when Summers had been part of a government that basically got out of the way of the financial markets as they headed for the edge of the cliff.

    Summers responded by quoting John Maynard Keynes, whose economic theory calling for massive government spending became identified with Roosevelt's New Deal and is at the heart of the Obama administration's stimulus plan. "Keynes famously said of someone who accused him of inconsistency: 'When circumstances change, I change my opinion'," said Summers, raising his heavy-lidded eyes at the reporters as he quoted Keynes's kicker: " 'What do you do?' " The implication, not so subtle, is that smart people are not dogmatic—stuck in one narrow ideological groove —but rather open-minded, flexible and intellectually alert—able to change with the times.

    . . .

    Some of the stories go well beyond complaints about his manners. Brooksley Born, chairwoman of the Commodity Futures Trading Commission, received a call in March 1998 in her office in downtown Washington. On the other end was Deputy Treasury Secretary Summers. According to witnesses at the CFTC, Summers proceeded to dress her down, loudly and rudely. "She was ashen," recalls Born's deputy Michael Greenberger, who walked in as the call was ending. "She said, 'That was Larry Summers. He was shouting at me'." A few weeks before, Born had put out a proposal suggesting that U.S. authorities begin exploring how to regulate the vast global market in derivatives. Summers's phone call was the first sign that her humble plan had riled America's reigning economic elite.

    Rubin, Fed chairman Alan Greenspan and Summers were concerned that even a hint of regulation would send all the derivatives trading overseas, costing America business. Summers bluntly insisted that Born drop her proposal, says Greenberger. According to another former CFTC official who would recount the episode only on condition of anonymity, Born was "astonished" Summers would take the position "that you shouldn't even ask questions about a market that was many, many trillions of dollars in notional value—and that none of us knew anything about."

    Arthur Levitt, who was head of the SEC at the time of Born's proposal, today admits flatly that she had things right about derivatives while he, Rubin, Greenspan and Summers didn't. ("All tragedies in life are preceded by warnings," Levitt says. "We had a warning. It was from Brooksley Born. We didn't listen.") Summers told NEWSWEEK: "I believed at the time, and believe much more strongly today, that new regulations with respect to systemic risk were appropriate and necessary, but expressed the strong view of Secretary Rubin, chairman Greenspan and SEC chief Levitt that the way the CFTC was proposing to go about it was likely to be ineffective and itself imposed major risks into the market." (At the time, the Rubin Treasury Department argued against the Born proposal by maintaining that the CFTC didn't have legal jurisdiction.) Still, Summers allowed that "there's no question that with hindsight, stronger regulation would have been appropriate" before the financial crash. He added: "Large swaths of economics are going to have to be rethought on the basis of what's happened." In the past year Summers has refashioned himself as a champion of intensive financial regulation. In his last column for the Financial Times before joining the Obama administration, Summers said the pendulum "should now swing towards an enhanced role for government in saving the market system from its excesses and inadequacies."

    Continued in article

    Bob Jensen's timeline on the disasters of not regulating markets for derivative financial instruments --- http://www.trinity.edu/rjensen/FraudRotten.htm#DerivativesFrauds


     Derivatives Financial Instruments History Paper
    "Leveraging the British Railway Mania: Derivatives for the Individual Investor"
    Campbell, Gareth (2010):
    Leveraging the British Railway Mania: Derivatives for the Individual Investor. Unpublished.
    http://mpra.ub.uni-muenchen.de/21822/

    Abstract
    During the British Railway Mania of the 1840s the promotion and construction of new railways increased dramatically. These new projects were generally financed by shares with uncalled capital, which allowed investors to make payments on an installment basis over a period of several years. There is evidence that these assets can be regarded as futures or options, implying that investors were purchasing highly leveraged derivatives. The leverage embedded in these assets multiplied both the positive returns during the boom, and the negative returns during the downturn. It also affected the payment schedule for investors as little capital was required initially, but the subsequent ‘calls for capital’ resulted in deleveraging.

     

    Item Type: MPRA Paper
    Language: English
    Keywords: bubbles, financial crises, Railway Mania
    Subjects: G - Financial Economics > G1 - General Financial Markets > G12 - Asset Pricing; Trading volume; Bond Interest Rates
    N - Economic History > N2 - Financial Markets and Institutions > N23 - Europe: Pre-1913
    G - Financial Economics > G1 - General Financial Markets > G13 - Contingent Pricing; Futures Pricing
    G - Financial Economics > G0 - General > G01 - Financial Crises
    ID Code: 21822
    Deposited By: Gareth Campbell
    Deposited On: 07. Apr 2010 03:49
    Last Modified: 07. Apr 2010 09:28
    References: Allen, F. & Gale, D. (1997), ‘Bubbles and Crises’, The Economic Journal, vol. 110(460), pp. 236-55.

    Aoki, K., Proudman, J., and Vlieghe, G. (2002). ‘Houses as Collateral: Has the Link between House Prices and Consumption in the U.K. Changed?’, Economic Policy Review, Federal Reserve Bank of New York, May, pp. 163-77

    Bernanke, B.S., and Gertler, M. (2001). 'Should Central Banks Respond to Movements in Asset Prices?' American Economic Review, vol. 91 (May), pp. 253-57.

    Black, F. & Scholes, M. (1973), ‘The Pricing of Options and Corporate Liabilities’, Journal of Political Economy, vol. 81, no. 3, pp. 637.

    Campbell, G. (2010), “Cross-Section of a ‘Bubble’: Stock Prices and Dividends during the British Railway Mania”, SSRN Working Paper.

    Campbell, G. and Turner, J. (2010), “‘The Greatest Bubble in History’: Stock Prices during the British Railway Mania”, SSRN Working Paper.

    Course of the Exchange (1843-50).

    Dale, R., Johnson, J.E.V. & Tang, L. (2005), ‘Financial Markets can Go Mad: Evidence of Irrational Behaviour during the South Sea Bubble’, Economic History Review, vol. 58, no. 2, pp. 233-271.

    Detken, C. and Smets, F. (2004), 'Asset Price Booms and Monetary Policy', ECB Working Paper no. 364. Economist (1843-50).

    Engle, R. F. and Granger, C.W.J. (1987), ‘Co-Integration and Error Correction: Representation, Estimation, and Testing’, Econometrica, vol. 55, pp.251-276.

    Foote, C.L., Gerardi, K. & Willen, P.S. (2008), ‘Negative Equity and Foreclosure: Theory and evidence’, Journal of Urban Economics, vol. 64(2), pp. 234-245.

    Froot, K.A. & Dabora, E.M. (1999), ‘How are Stocks Affected by the Location of Trade?’, Journal of Financial Economics, vol. 53, pp. 189-216.

    Guiso, L., Sapienza, P. & Zingales, L. (2009), ‘Moral and Social Constraints to Strategic Default on Mortgages’, CEPR Working Paper.

    Hull, J. (2003), Options, Futures, and other Derivatives, Pearson Prentice Hall.

    Jackman, W.T. (1966), The Development of Transportation in Modern England, Cass.

    Johansen, S. (1988), ‘Statistical Analysis Of Cointegration Vectors’, Journal of Economic Dynamics and Control, vol. 12, no. 2-3, pp. 231-254.

    Kindleberger, C.P. (2000), Manias, Panics, and Crashes: A History of Financial Crises, John Wiley & Sons.

    Lamont, O.A. & Thaler, R.H. (2003), ‘Can the Market Add and Subtract? Mispricing in Tech Stock Carve-outs’, Journal of Political Economy, vol. 111, no. 2, pp. 227-268.

    Lewin, H.G. (1968), The Railway Mania and its Aftermath, 1845-1852 (Being a Sequel to Early British Railways), Rev. Edn, A. M. Kelley.

    MacDermot, E.T. (1964), History of the Great Western Railway, Ian Allan Ltd.

    Mitchell, B.R. (1964), ‘The Coming of the Railway and United Kingdom Economic Growth’, Journal of Economic History, vol. 24, no. 3, pp. 315-336.

    Murphy, A.L. (2009), ‘Trading Options before Black-Scholes: A Study of the Market in Late Seventeenth Century London’, Economic History Review, vol. 62, no. S1, pp. 8-30.

    Nairn, A. (2002), Engines that Move Markets: Technology Investing from Railroads to the Internet and Beyond, Wiley.

    Parliamentary Papers (1847-48), LXIII, p.275-442 ‘Return of the names of railways for which acts have been obtained; calls made; amount received and remaining due; sums borrowed which remain owing; balance of capital uncalled for, and of money which the companies retain power to borrow; and, periods for which the companies have postponed making further calls.’

    Parliamentary Papers (1847-48), VIII, Pt. I, p.1, ‘Reports from the Secret Committee on Commercial Distress; with an Index’.

    Pollins, H. (1971), Britain's Railways: An Industrial History, David and Charles (Publishers) Limited. Railway Times (1843-50).

    Shea, G.S. (2007a), ‘Understanding Financial Derivatives During the South Sea Bubble: The Case of the South Sea Subscription Shares’, Oxford Economic Papers, vol. 59, no. Supplement 1, pp. i73.

    Shea, G.S. (2007b), ‘Financial Market Analysis Can Go Mad (in the Search for Irrational Behaviour During the South Sea Bubble)’, Economic History Review, vol. 60, no. 4, pp. 742-765.

    Simmons, J. (1978), The Railway in England and Wales, 1830-1914, vol.1, Leicester University Press.

    Stock, J.H. & Watson, M.W. (2003), Introduction to Econometrics, Addison Wesley.

    The Railway Investment Guide. How to Make Money in Railway Shares: A Series of Hints and Advice to Parties Speculating (1845).

    The Times (1843-50).

    Tuck, H. (1845), The Railway Shareholder's Manual; Or Practical Guide to All the Railways in the World, Sixth Edition, Effingham Wilson.

    Tuck, H. (1848), The Railway Shareholder's Manual; Or Practical Guide to All the Railways in the World, Eighth Edition, Effingham Wilson.

     

    Bob Jensen's free tutorials and videos on accounting for derivative financial instruments and hedging activities ---
    http://www.trinity.edu/rjensen/caseans/000index.htm


    Question
    What are hedge funds, especially after Bernie Madoff made them so famous?

    When people ask me this question, my initial response is that a hedge fund no longer necessarily has anything to do with financial risk hedging. Rather a hedge fund is merely a "private" investment "club" that does not offer shares to the general public largely because it would then subject itself to more SEC, stock exchange, and other regulators. Having said this, it's pretty darn easy for anybody with sufficient funds to get into such a "private" club. Minimum investments range from $10,000 to $1,000,000 or higher.

    Since Bernie Madoff made hedge funds so famous, the public tends to think that a hedge fund is dangerous, fraudulent, and a back street operation that does not play be the rules. Certainly hedge funds emerged in part to avoid being regulated. Sometimes they are risky due to high leverage, but some funds skillfully hedge to manage risk and are much safer than mutual funds. For example, some hedge funds have shrewd hedging strategies to control risk in interest rate and/or foreign currency trading.

    Most hedge funds are not fraudulent. In general, however, it's "buyer beware" for hedge fund investors.

    I would never invest in a hedge fund that is not audited by a very reliable CPA auditing firm. Not all CPA auditing firms are reliable (Bernie Madoff proved you can engage a fraudulent auditor operating out of a one-room office). Hence, the first step in evaluating a hedge fund is to investigate its auditor. The first step in evaluating an auditor is to determine if the auditing firm is wealthy enough to be a serious third party in law suits if the hedge fund goes belly up.

    But the recent multimillion losses of Carnegie Mellon, the University of Pittsburgh, and other university endowment funds that invested in a verry fraudulent hedge fund purportedly audited by Deloitte suggests that the size and reputation of the auditing firm is not, by itself, sufficient protection against a criminal hedge fund (that was supposedly given a clean opinion by Deloitte in financial reports circulated to the victims of the fraud).

    When learning about hedge funds, you may want to begin at http://en.wikipedia.org/wiki/Hedge_Fund

    "What is a hedge fund and how is it different from a mutual fund?" by Andy Samuels, Business and Finance 101 Examiner, June 10, 2009 --- Click Here
    Jim Mahar pointed out this link.

    Having migrated away from their namesake, hedge funds no longer  focus primarily on “hedging” (attempting to reduce risk) because hedge funds are now focused almost blindly on one thing: returns.

    Having been referred to as “mutual funds for the super rich” by investopedia.com, hedge funds are very similar to mutual funds in that they pool money together from many investors. Hedge funds, like mutual funds, are also managed by a financial professionals, but differ because they are geared toward wealthier individuals.

    Hedge funds, unlike mutual funds, employ a wider array of ivesting techniques, which are considered more aggresive. For example, hedge funds often use leverage to amplify their returns (or losses if things go wrong).

    The other key difference between hedge funds and mutual funds is the amount of regulation involved. Hedge funds are relatively unregulated because investors in hedge funds are assumed to be more sophisticated investors, who can both afford and understand the potential losses. In fact, U.S. laws require that the majority of investors in the fund are accredited.

    Most hedge funds draw in investors because of the trustworthy reputations of the executives of the fund. Word-of-mouth praise and affiliations are often the key to success. Bernie Madoff succeed in luring customers based on two leading factors:  (1) His esteemed reputation on Wall Street and (2) His highly regarded connections in the Jewish community where he drew in most of his victims.

    A Bit of History
    German Chancellor's Call for Global Regulations to Curb Hedge Funds
    Germany and the United States are parting company again, this time over Chancellor Gerhard Schröder's call for international regulations to govern hedge funds. Treasury Secretary John W. Snow, speaking here Thursday at the end of a five-country European tour, said the United States opposed "heavy-handed" curbs on markets. He said that he was not familiar with the German proposals, but left little doubt about how Washington would react. "I think we ought to be very careful about heavy-handed regulation of markets because it stymies financial innovation," Mr. Snow said after a news conference here to sum up his visit. Noting that the Securities and Exchange Commission has proposed that hedge funds be required to register themselves, he said he preferred the "light touch rather than the heavy regulatory burden."
    Mark Landler, "U.S. Balks at German Chancellor's Call for Global Regulations to Curb Hedge Funds," The New York Times, June 17, 2005 --- http://www.nytimes.com/2005/06/17/business/worldbusiness/17hedge.html?

    An investing balloon that will one day burst
    The numbers are mind-boggling: 15 years ago, hedge funds managed less than $40 billion. Today, the figure is approaching $1 trillion. By contrast, assets in mutual funds grew at an impressive but much slower rate, to $8.1 trillion from $1 trillion, during the same period. The number of hedge fund firms has also grown - to 3,307 last year, up 74 percent from 1,903 in 1999. During the same period, the number of funds created - a manager can start more than one fund at a time - has surged 209 percent, with 1,406 funds introduced in 2004, according to Hedge Fund Research, based in Chicago.
    Jenny Anderson and Riva D. Atlas, "If I Only Had a Hedge Fund," The New York Times, The New York Times, March 27, 2005 --- http://www.nytimes.com/2005/03/27/business/yourmoney/27hedge.html 
    Jensen Comment:  The name "hedge fund" seems to imply that risk is hedged.  Nothing could be further from the case.  Hedge funds do not have to hedge risks,  Hedge funds should instead be called private investment clubs.  If structured in a certain way they can avoid SEC oversight.  

    Remember how the Russian space program worked in the 1960s? The only flights that got publicized were the successful ones.  Hedge funds are like that. The ones asking for your money have terrific records. You don't hear about the ones that blew up. That fact should strongly color your view of hedge funds with terrific records.
    Forbes, January 13, 2005 --- http://snipurl.com/ForbesJan_13 

    US hedge funds prior to 2005 were exempted from Securities and Exchange Commission reporting requirements, as well as from regulatory restrictions concerning leverage or trading strategies. They now must register with the SEC except under an enormous loophole for funds that cannot liquidate in less than two years.

    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.

     

    Bob Jensen's threads on frauds are linked at http://www.trinity.edu/rjensen/fraud.htm
    In particular see http://www.trinity.edu/rjensen/fraud001.htm
    And see http://www.trinity.edu/rjensen/FraudRotten.htm


    Unlike many other nations that either did not have national accounting standards or had weak and incomplete sets of standards, the FASB over the years produced the best set of accounting standards in the world (although there is no such thing a perfect set since companies are always writing contracts to circumvent most any standard). The FASB standards were heavily rule-based due to the continual battles fought by the FASB in the trenches of U.S. firms seeking to manage earnings and keep debt of the balance sheet with ever-increasing contract complexities such as interest rate swaps invented in the 1980s, SPE ploys, securitization "sales," synthetic leasing, etc.
                         

    • The experiences of those frazzled executives in charge of reducing risks in the credit derivatives market are starting to resemble Alice’s adventures in Wonderland. Alice shrank after drinking a potion, but was then too small to reach the key to open the door. The cake she ate did make her grow, but far too much. It was not until she found a mushroom that allowed her to both grow and shrink that she was able to adjust to the right size, and enter the beautiful garden. It took an awfully long time, with quite a number of unpleasant experiences, to get there.
      Aline van Duyn, "The adventure never ends in the derivatives Wonderland," Financial Times, September 11, 2008 --- Click Here

       
    • While Lehman Brothers was fighting for its life in the markets today, it was also battling in a Senate panel's hearing on whether the company and others created a set of financial products whose primary purpose is to dodge taxes owned on U.S. stock dividends. The "most compelling" reason for entering into dividend-related stock swaps are the tax savings, Highbridge Capital Management Treasury and Finance Director Richard Potapchuk told the Senate's Permanent Subcommittee on Investigations. Lehman Brothers (nyse: LEH - news - people ), Morgan Stanley (nyse: MS - news - people ) and Deutsche Bank (nyse: DB - news - people ) are among the companies behind the products.
      Anitia Raghaven, The Tax Dodge Derivative, Forbes, September 11, 2008 --- Click Here
       

       

    • What's Right and What's Wrong With (SPEs), SPVs, and VIEs ---
                            http://www.trinity.edu/rjensen//theory/00overview/speOverview.htm

    "Taking liberties (and tax dollars)," by Prem Sekka, The Guardian, September 15, 2008 --- http://www.guardian.co.uk/commentisfree/2008/sep/15/creditcrunch.taxandspending

    Financial institutions are teetering and are relying on the taxpayer to bail them out. Fannie Mae and Freddie Mac have effectively been nationalised at a possible cost of $200bn (£111.3bn) or more. A soft loan of $29bn persuaded JP Morgan to buy Bear Stearns. Lehman Brothers has filed for bankruptcy. Merrill Lynch has been swallowed by Bank of America. Commercial banks are borrowing around $19bn a day from the US Treasury's emergency lending programme to keep them afloat and new rescue funding is being created. Northern Rock has been bailed out by the UK taxpayer. The Bank of England has provided around £200bn of emergency funding to support financial institutions. The European Central Bank has lent banks some €467bn (£378bn) as it tries to deal with chaos manufactured in corporate boardrooms.

    Banks are expecting taxpayers to save them from the consequences of poor financial decisions. Yet at the same time, behind a veil of secrecy, they have been eroding tax revenues by designing and marketing tax-avoidance schemes.

    A recent investigation by the US Senate permanent subcommittee on investigations found that major financial institutions have "devised complex financial structures to enable their offshore clients to dodge US dividend taxes". The offshore dodges are estimated to cost the US Treasury around $100bn a year in lost tax revenues. The Senate subcommittee highlighted the use of stock swaps and stock lending transactions to avoid taxes on dividends paid by US companies. Its report focuses on transactions devised and carried out by Lehman Brothers, Morgan Stanley, Deutsche Bank, UBS, Merrill Lynch and Citigroup.

    The data available to the subcommittee – page 8 of the report (pdf) – showed that from 2000-2007, Morgan Stanley's dividend transactions:

    ... enabled clients to escape payment of US dividend taxes totalling more than $300m. An internal Lehman Brothers presentation estimates that, in 2004 alone, its transactions enabled clients to dodge payment of dividend taxes of as much as $115m. UBS data on its stock loan transactions over a four-year period, from 2004 to 2007, indicate that its clients escaped payment of US dividend taxes totalling about $62m ... Maverick Capital Management, calculated that over an eight-year period, from 2000 to 2007, it had entered into 'US Dividend Enhancements' with a variety of firms that enabled it to escape paying US dividend taxes totalling nearly $95m ... Citigroup told the IRS that it had failed to withhold dividend taxes on a limited set of transactions from 2003 to 2005, and voluntarily paid those taxes which totalled $24m.

    Needless to say, the financial institutions made significant profits from the above transactions. The subcommittee report (page 7) notes:

    Morgan Stanley estimated that its 2004 revenues from its dividend-related transactions totalled $25m. Lehman calculated that its Cayman stock-lending operations produced a 2003 profit of $12m, and projected doubling those profits the next year to $25m. UBS estimated its 2005 profits at $5m and predicted double that amount in 2006. Deutsche Bank stated that, in 2007, its stock loans alone had produced profits of $4m.

    In an earlier inquiry (pdf) into tax avoidance, the Senate subcommittee found (page 9) that banks played a key role in the schemes marketed by KPMG. It stated that "Major banks, such as Deutsche Bank, HVB, UBS, and NatWest, provided purported loans for tens of millions of dollars essential to the orchestrated transactions".

    The above practices may well be replicated around the globe, facilitating enormous leakage of tax revenues. Banks routinely make claims about ethical behaviour and social responsibility. Yet their statements are not matched by their practices. In pursuit of private profits they facilitate tax avoidance and erode tax revenues. Ironically, these are the very revenues that, as we have seen, can be used to save them.

    Chief executives of banks have collected fat-cat salaries, but none have offered any apology or explanation for their predatory practices, or shed light on their offshore dealings. Whatever the outcome of the current financial crisis, tougher regulation is needed to curb the tax-avoidance industry. The deposit-taking licence of banks peddling tax-avoidance schemes should be withdrawn. Their executives should be made personally liable for the losses inflicted on the taxpayers


    Greenspan's Disastrous Agency Problem
    In political science and economics, the principal-agent problem or agency dilemma treats the difficulties that arise under conditions of incomplete and asymmetric information when a principal hires an agent. Various mechanisms may be used to try to align the interests of the agent with those of the principal, such as piece rates/commissions, profit sharing, efficiency wages, performance measurement (including financial statements), the agent posting a bond, or fear of firing. The principal-agent problem is found in most employer/employee relationships, for example, when stockholders hire top executives of corporations. Numerous studies in political science have noted the problems inherent in the delegation of legislative authority to bureaucratic agencies. The implementation of legislation (such as laws and executive directives) is open to bureaucratic interpretation, creating opportunities and incentives for the bureaucrat-as-agent to deviate from the intentions or preferences of the legislators. Variance in the intensity of legislative oversight also serves to increase principal-agent problems in implementing legislative preferences.

    Wikipedia --- http://en.wikipedia.org/wiki/Agency_theory

     

    Not only have individual financial institutions become less vulnerable to shocks from underlying risk factors, but also the financial system as a whole has become more resilient.
    Alan Greenspan in 2004 as quoted by Peter S. Goodman, Taking a Good Look at the Greenspan Legacy," The New York Times, October 8, 2008 --- http://www.nytimes.com/2008/10/09/business/economy/09greenspan.html?em

    The problem is not that the contracts failed, he says. Rather, the people using them got greedy. A lack of integrity spawned the crisis, he argued in a speech a week ago at Georgetown University, intimating that those peddling derivatives were not as reliable as “the pharmacist who fills the prescription ordered by our physician.”

    But others hold a starkly different view of how global markets unwound, and the role that Mr. Greenspan played in setting up this unrest.

    “Clearly, derivatives are a centerpiece of the crisis, and he was the leading proponent of the deregulation of derivatives,” said Frank Partnoy, a law professor at the University of San Diego and an expert on financial regulation.

    The derivatives market is $531 trillion, up from $106 trillion in 2002 and a relative pittance just two decades ago. Theoretically intended to limit risk and ward off financial problems, the contracts instead have stoked uncertainty and actually spread risk amid doubts about how companies value them.

    If Mr. Greenspan had acted differently during his tenure as Federal Reserve chairman from 1987 to 2006, many economists say, the current crisis might have been averted or muted.

    Over the years, Mr. Greenspan helped enable an ambitious American experiment in letting market forces run free. Now, the nation is confronting the consequences.

    Derivatives were created to soften — or in the argot of Wall Street, “hedge” — investment losses. For example, some of the contracts protect debt holders against losses on mortgage securities. (Their name comes from the fact that their value “derives” from underlying assets like stocks, bonds and commodities.) Many individuals own a common derivative: the insurance contract on their homes.

    On a grander scale, such contracts allow financial services firms and corporations to take more complex risks that they might otherwise avoid — for example, issuing more mortgages or corporate debt. And the contracts can be traded, further limiting risk but also increasing the number of parties exposed if problems occur.

    Throughout the 1990s, some argued that derivatives had become so vast, intertwined and inscrutable that they required federal oversight to protect the financial system. In meetings with federal officials, celebrated appearances on Capitol Hill and heavily attended speeches, Mr. Greenspan banked on the good will of Wall Street to self-regulate as he fended off restrictions.

    Ever since housing began to collapse, Mr. Greenspan’s record has been up for revision. Economists from across the ideological spectrum have criticized his decision to let the nation’s real estate market continue to boom with cheap credit, courtesy of low interest rates, rather than snuffing out price increases with higher rates. Others have criticized Mr. Greenspan for not disciplining institutions that lent indiscriminately.

    But whatever history ends up saying about those decisions, Mr. Greenspan’s legacy may ultimately rest on a more deeply embedded and much less scrutinized phenomenon: the spectacular boom and calamitous bust in derivatives trading.

    Bob Jensen's timeline of derivatives scandals and the evolution of accounting standards for accounting for derivatives financial instruments can be found at http://www.trinity.edu/rjensen/FraudCongress.htm#DerivativesFrauds

    "‘I made a mistake,’ admits Greenspan," by Alan Beattie and James Politi, Financial Times, October 23, 2008 ---
    http://www.ft.com/cms/s/0/aee9e3a2-a11f-11dd-82fd-000077b07658.html?nclick_check=1

    “I made a mistake in presuming that the self-interest of organisations, specifically banks and others, was such that they were best capable of protecting their own shareholders,” he said.

    In the second of two days of tense hearings on Capitol Hill, Henry Waxman, chairman of the House of Representatives, clashed with current and former regulators and with Republicans on his own committee over blame for the financial crisis.

    Mr Waxman said Mr Greenspan’s Federal Reserve – along with the Securities and Exchange Commission and the US Treasury – had propagated “the prevailing attitude in Washington... that the market always knows best.”

    Mr Waxman blamed the Fed for failing to curb aggressive lending practices, the SEC for allowing credit rating agencies to operate under lax standards and the Treasury for opposing “responsible oversight” of financial derivatives.

    Christopher Cox, chairman of the Securities and Exchange Commission, defended himself, saying that virtually no one had foreseen the meltdown of the mortgage market, or the inadequacy of banking capital standards in preventing the collapse of institutions such as Bear Stearns.

    Mr Waxman accused the SEC chairman of being wise after the event. “Mr Cox has come in with a long list of regulations he wants... But the reality is, Mr Cox, you weren’t doing that beforehand.”

    Mr Cox blamed the fact that congressional responsibility was divided between the banking and financial services committees, which regulate banking, insurance and securities, and the agriculture committees, which regulate futures.

    “This jurisdictional split threatens to for ever stand in the way of rationalising the regulation of these products and markets,” he said.

    Mr Greenspan accepted that the crisis had “found a flaw” in his thinking but said that the kind of heavy regulation that could have prevented the crisis would have damaged US economic growth. He described the past two decades as a “period of euphoria” that encouraged participants in the financial markets to misprice securities.

    He had wrongly assumed that lending institutions would carry out proper surveillance of their counterparties, he said. “I had been going for 40 years with considerable evidence that it was working very well”.

    Continued in the article

    Jensen Comment
    In other words, he assumed the agency theory model that corporate employees, as agents of their owners and creditors, would act hand and hand in the best interest for themselves and their investors. But agency theory has a flaw in that it does not understand Peter Pan.

    Peter Pan, the manager of Countrywide Financial on Main Street, thought he had little to lose by selling a fraudulent mortgage to Wall Street. Foreclosures would be Wall Street’s problems and not his local bank’s problems. And he got his nice little commission on the sale of the Emma Nobody’s mortgage for $180,000 on a house worth less than $100,000 in foreclosure. And foreclosure was almost certain in Emma’s case, because she only makes $12,000 waitressing at the Country Café. So what if Peter Pan fudged her income a mite in the loan application along with the fudged home appraisal value? Let Wall Street or Fat Fannie or Foolish Freddie worry about Emma after closing the pre-approved mortgage sale deal. The ultimate loss, so thinks Peter Pan, will be spread over millions of wealthy shareholders of Wall Street investment banks. Peter Pan is more concerned with his own conventional mortgage on his precious house just two blocks south of Main Street. This is what happens when risk is spread even farther than Tinkerbell can fly!
    Also see how corporate executives cooked the books --- http://www.trinity.edu/rjensen/theory01.htm#Manipulation

    The Saturday Night Live Skit on the Bailout --- http://patdollard.com/2008/10/it-is-here-the-banned-snl-skit-cannot-hide-from-louie/ 

    Peter, Paul, and Barney: An Essay on 2008 U.S. Government Bailouts of Private Companies ---
    http://www.trinity.edu/rjensen/2008Bailout.htm

    Bob Jensen's threads on earnings management and creative accounting to cook the books ---
    http://www.trinity.edu/rjensen/theory01.htm#Manipulation

     

     


    "What’s a Couple of Hundred Trillion When You’re Talking Derivatives?" by Floyd Norris, The New York Times, September 23, 2006 --- http://www.nytimes.com/2006/09/23/business/23charts.html

    Types of Basic Derivative Financial Instruments (there are many complicated variations and structures)

    Type of contract

    Main pricing-settlement variable (underlying variable)

    Interest rate swap

    Interest rates

    Currency swap (foreign exchange swap)

    Currency rates

    Commodity swap

    Commodity prices

    Equity swap

    Equity prices (equity of another entity)

    Credit swap

    Credit rating, credit index or credit price

    Total return swap

    Total fair value of the reference asset and interest rates

    Purchased or written treasury bond option (call or put)

    Interest rates

    Purchased or written currency option (call or put)

    Currency rates

    Purchased or written commodity option (call or put)

    Commodity prices

    Purchased or written stock option (call or put)

    Equity prices (equity of another entity)

    Interest rate futures linked to government debt (treasury futures)

    Interest rates

    Currency futures

    Currency rates

    Commodity futures

    Commodity prices

    Interest rate forward linked to government debt (treasury forward)

    Interest rates

    Currency forward

    Currency rates

    Commodity forward

    Commodity prices

    Equity forward

    Equity prices (equity of another entity)

    In fact, certain types of derivatives have existed for thousands of years --- farmers used forwards to hedge and the ancient Greeks used options to speculate --- most derivatives innovation has occurred in the (1980s), and most of the derivatives Morgan Stanley was selling in 1994 were new. The majority of derivatives (our Derivatives Product Group, DPG) sold --- including structured notes and interest rate swaps . . . didn't exist before 1980, Once Wall street began creating these derivatives, their use and popularity skyrocketed .... The DPG sold risky, leveraged derivates . . .
    Frank Partnoy, Page 51 of Chapter 8 entitled "The House of Cards"
    F.I.A.S.C.O. : The Inside Story of a Wall Street Trader by Frank Partnoy
    - 283 pages (February 1999) Penguin USA (Paper); ISBN: 0140278796 

    Infectious Greed:  How Deceit and Risk Corrupted the Financial Markets  (Henry Holt and Company, 2003, Page 187, ISBN 0-8050-7510-0)

    The Regulatory changes of 1994-95 (including the Private Securities Litigation Reform Act (PSLRA) of 1995 better known as the white collar crime invitation act) sent three messages to corporate CEOs.

    1. First, you are not likely to be punished for "massaging" your firm's accounting numbers. Prosecutors rarely go after financial fraud and, even when they do, the typical punishment is a small fine; almost no one goes to prison. Moreover, even a fraudulent scheme could be recast as mere earnings management --- the practice of smoothing a company's earnings --- which most executives did, and regarded as perfectly legal.
       
    2. Second, your should use new financial instruments ---- including options, swaps, and other derivatives --- to increase your own pay and to avoid costly regulation. If complex derivatives are too much for you to handle --- as they were for many CDOs during the years immediately following the 1994 losses --- you should at least pay yourself in stock ooptions, which need to be disclosed as an expense (this was later changed in FAS 123(R)) and have greater upside than cash bonuses or stock.
       
    3. Third, you don't need to worry about whether accountants or security analysts will tell investors about any hidden losses or excessive options pay. Now that Congress and the Supreme Court have insulated accounting firms and investment banks from liability --- with the Central Bank decision and the Private Securities Litigation Reform Act --- they will be much more willing to look the other way. If you pay them enough in fees, they might even be willing to help.

     

     

    Timeline of Derivative Financial Instrument Frauds and Risks and Accounting Rules
    Derivative financial instruments include forward contracts, futures contracts, commodities swaps, interest rate swaps, purchased options, written (sold) options, swaptions, and many combinations thereof that that are defined at http://www.trinity.edu/rjensen/acct5341/speakers/133glosf.htm
    They are peculiar since they typically have zero or only a very small value when the contracts are initiated, but aside from purchased options they can have enormous risks. They can be used as speculations or as hedges in the management of financial risk. They became and still are enormously popular for hedging risk.

    Scandals involving some types of derivatives date back to Roman times when Romans used option contracts. Over the years there have been many scandals where one party takes advantage of another party to the contract. This timeline will summarize only some of the scandals that arose since 1980 when derivatives increased in popularity for organization treasurers and investment fund managers to either manage financial risk with derivatives or speculate in derivatives to earn high returns. Sometimes these managers/investors did not understand the unbelievably complex contracts, many fraudulent, that major Wall Street firms like were trying to push on them.

    The International Swaps and Derivatives Association, a trade group, reported in 2006 that the outstanding nominal (notional) value of swaps and derivatives at the end of June was $283.2 trillion.

    History of the U.S. Financial Accounting Standards Board (FASB) and earlier accounting standard setting in the United States --- http://www.trinity.edu/rjensen/Theory01.htm#AccountingHistory

    History of the International Accounting Standards Board (IASB) ---  http://www.iasb.org/About+Us/About+the+Foundation/History.htm
    A ommentary on the history of the IASC and IASB by Paul Pacter --- http://www.trinity.edu/rjensen/acct5341/speakers/pacter.htm#001
    Paul is the Webmaster of
    The IAS Plus International Standards Blog of Deloitte. That blog provides an excellent summary of the history of IAS 39 and all its amendments to date --- http://www.iasplus.com/standard/ias39.htm
    Paul is the Webmaster of The IAS Plus International Standards Blog of Deloitte. That blog provides an excellent summary of the history of IAS 39 and all its amendments to date --- http://www.iasplus.com/standard/ias39.htm
    Also see http://static.managementboek.nl/pdf/9780471726883.pdf

    Some of the many, many lawsuits settled by auditing firms can be found at http://www.trinity.edu/rjensen/Fraud001.htm

    Frank Partnoy, Page 283 of a Postscript entitled "The Return"
    F.I.A.S.C.O. : The Inside Story of a Wall Street Trader
    by Frank Partnoy - 283 pages (February 1999) Penguin USA (Paper); ISBN: 0140278796 

    Perhaps we don' think we deserve a better chance. We play the lottery in record numbers, despite the 50 percent cut (taken by the government). We flock to riverboat casinos, despite substantial odds against winning. Legal and illegal gambling are growing just as fast as the financial markets, Las Vegas is our top tourist destination in the U.S., narrowly edging out Atlantic City. Are the financial markets any different? In sum, has our culture become so infused with the gambling instinct that we would afford investors only that bill of rights given a slot machine player:  the right to pull the handle, their right to pick a different machine, the right to leave the casino, abut not the right to a fair game.

    Chronology of IFRS standards --- http://www.iasplus.com/restruct/chrono.htm


    A Primer on Derivatives

    I think there are two CBS Sixty Minutes television modules by Steve Kroft that the entire world should view. These are great videos for college students to view while keeping in mind that both videos are negatively biased. What follows is my primer in defense of derivative financial instruments and hedging activities.

    CBS Video Module 1
    Financial Derivatives Scandals Explode in 1995

     

     

    CBS Video Module 2
    Credit Derivatives Scandals Explode in 2008
    •  Steve Kroft on Sixty Minutes, October 26, 2008 ---
      Introductory Segment if Credit Default Swaps --- http://www.cbsnews.com/video/watch/?id=4501762n%3fsource=search_video
      This video features my hero, Frank Partnoy, who has a great set of books on derivatives scandals (he was once a crook). Frank Partnoy's Senate testimony is the probably the best explanation of how Enron cheated with derivatives --- http://www.trinity.edu/rjensen/FraudEnronQuiz.htm#16
      The Year 2000 controversial law referred to in the video is the Commodity Futures Modernization Act of 2000 --- http://en.wikipedia.org/wiki/Commodities_Futures_Modernization_Act
      Also see http://knowledge.wpcarey.asu.edu/article.cfm?articleid=1682
       
    • Examples of derivative contracts that even the professional analysts could not decipher  and a history of derivatives contracting scandals --- http://www.trinity.edu/rjensen/fraud.htm#DerivativesFraud 
       
    • A Great Slide Show on Credit Derivatives --- http://www.isda.org/c_and_a/ppt/PRMIAISDAFinal.ppt#261,10,Modelling Legal Risk?
      Or view the HTML version --- Click Here
       
    • Frank Partnoy is best known as a whistle blower at Goldman Sachs who blew the lid on the financial graft and sexual degeneracy of derivatives instruments traders and analysts who ripped the public off for billions of dollars and contributed to mind-boggling worldwide frauds.  He is a Yale University Law School graduate who shocked the world with various books  (somewhat repetitive) including the following:
      • FIASCO: The Inside Story of a Wall Street Trader
      • FIASCO: Blood in the Water on Wall Street
      • FIASCO:  Blut an den weißen Westen der Wall Street Broker.
      • FIASCO: Guns, Booze and Bloodlust: the Truth About High Finance
      • Infectious Greed : How Deceit and Risk Corrupted the Financial Markets
      • Codicia Contagiosa

      His other publications include the following highlight:

      "The Siskel and Ebert of Financial Matters: Two Thumbs Down for the Credit Reporting Agencies" (Washington University Law Quarterly)

       


    Mr. Buffett, who has interests in both companies, claimed there was another agenda (aside from hedging with derivatives). “The reason many of them do it (invest in derivative contracts) is that they want to smooth earnings,” he said, referring to the idea of trying to make quarterly numbers less volatile. “And I’m not saying there’s anything wrong with that, but that is the motivation.”
    "Derivatives, as Accused by Buffett," by Andrew Ross Sorkin, The New York Times, March 14, 2011 ---
    http://dealbook.nytimes.com/2011/03/14/derivatives-as-accused-by-buffett/?ref=business

    Mr. Buffett once described derivatives as “financial weapons of mass destruction.” Yet some of his most ardent fans have quietly raised eyebrows at his pontifications, given that he plays in the opaque market. In the fourth quarter alone, Berkshire made $222 million on derivatives. TheStreet.com published a column last spring with the headline: “Warren Buffett Is a Hypocrite.”

    ¶His comments, which were released last month by the financial crisis commission, come as the government is writing rules for derivatives as part of the Dodd-Frank financial regulatory overhaul. And the statements could influence the debate.

    ¶Mr. Buffett appeared to backpedal from his oft-quoted line, explaining: “I don’t think they’re evil per se. It’s just, they, I mean there’s nothing wrong with having a futures contract or something of the sort. But they do let people engage in massive mischief.”

    ¶The problems arise, Mr. Buffett said, when a bank’s exposure to derivatives balloons to grand proportions and uninformed investors start using them.

    ¶It “doesn’t make much difference if it’s, you know, one guy rolling dice against another, and they’re doing $5 a throw. But it makes a lot of difference when you get into big numbers.”

    ¶What worries him most is the big financial institutions that have millions of contracts. “If I look at JPMorgan, I see two trillion in receivables, two trillion in payables, a trillion and seven netted off on each side and $300 billion remaining, maybe $200 billion collateralized,” he said, walking through his thinking. “That’s all fine. But I don’t know what discontinuities are going to do to those numbers overnight if there’s a major nuclear, chemical or biological terrorist action that really is disruptive to the whole financial system.”

    ¶“Who the hell knows what happens to those numbers?” he asked. “I think it’s virtually unmanageable.”

    ¶Mr. Buffett defended Berkshire Hathaway’s use of derivatives, arguing that the company maintains a limited amount. At the time of the interview, the company had only about 250 derivative contracts. (It’s now down to 203.) “I want to know every contract, and I can do that with the way we’ve done it. But I can’t do it with 23,000 that a bunch of traders are putting on.”

    ¶He noted that when Berkshire bought General Re in 1998, the reinsurance company had 23,000 derivative contracts. “I could have hired 15 of the smartest people, you know, math majors, Ph.D.’s. I could have given them carte blanche to devise any reporting system that would enable me to get my mind around what exposure that I had, and it wouldn’t have worked,” he said to the government panel. “Can you imagine 23,000 contracts with 900 institutions all over the world with probably 200 of them names I can’t pronounce?” Berkshire decided to unwind the derivative deals, incurring some $400 million in losses.

    ¶Mr. Buffett said he used derivatives to capitalize on discrepancies in the market. (That’s what other investors must think they are doing — just not as successfully.)

    ¶Perhaps the most insightful nugget in the interview was Mr. Buffett’s explanation of why corporations use derivatives — and why they probably shouldn’t.

    ¶Many companies, as diverse as Coca-Cola and Burlington Northern, argue that they employ derivatives to hedge their risk.

    ¶The United States-based Coca-Cola tries to protect against fluctuations in currencies since it does business around the world. Burlington Northern, the railroad giant, uses the investments to limit the effect of fuel prices.

    ¶Mr. Buffett, who has interests in both companies, claimed there was another agenda. “The reason many of them do it is that they want to smooth earnings,” he said, referring to the idea of trying to make quarterly numbers less volatile. “And I’m not saying there’s anything wrong with that, but that is the motivation.”

    ¶The numbers all even out eventually, he cautioned, so derivatives don’t really make much difference in the long term.

    ¶“They’re going to lose as much on the diesel fuel contracts over time as they make,” he said of Burlington Northern. “I wouldn’t do it.”

    Continued in article

    Bob Jensen's threads on creative accounting, smoothing, and earnings management ---
    http://www.trinity.edu/rjensen/Theory02.htm#Manipulation

    Bob Jensen's tutorials on accounting for derivative financial instruments ---
    http://www.trinity.edu/rjensen/caseans/000index.htm

     

     

    Related to the above television programs is "The Trillion Dollar Bet" video from PBS Nova --- http://www.trinity.edu/rjensen/2008Bailout.htm#LTCM
     

    Bob Jensen's Primer on Derivatives
    Although the roots of the sub-prime mortgage scandal lie in Main Street lending or more money for housing than borrowers could ever afford to pay off, the opportunity to do so was afforded by lenders like Countrywide Financial (a mortgage lending company owned by Bank of America) being able to pass on the default risk by selling the high risk mortgages to Fannie Mae and Freddie Mac, quasi government corporations that took the brunt of the loan losses. But some banks like Washington Mutual (WaMu became the largest bank failure in the history of the world) were greedy and kept huge portfolios of these high-return and high-risk mortgage investments.

    Fannie, Freddie, WaMu and the other risk takers assumed that the value of the real estate (the mortgage loan collateral) would be sufficient to pay back the loans in case of mortgage default foreclosures. But they underestimated the fraud going on on Main Street where property appraisers were fraudulently estimating real estate values way above market value and mortgage companies were lending way above amounts that borrowers would ever be able to pay back. My essay on the sub-prime mortgage scandal along with an alphabet soup set of appendices can be found at http://www.trinity.edu/rjensen/2008Bailout.htm

    In addition much of the current scandal also is attributed to Wall Street writing of credit derivative contracts that essentially "insured" against default of debt with counterparties investing in debt instruments that were "insured" by credit derivatives written by such giant firms as Bear Stearns and American Insurance Group (AIG). But unlike insurance where sufficient capital reserves are required, Congress passed legislation in Year 2000 that allowed Wall Street to write credit derivative insurance without having any capital reserves to cover the losses. Congress and the Wall Street firms just never anticipated the massive amount of mortgage defaults attributable to Main Street's lending frauds. When the magnitude of the amounts owing to counterparties on credit derivatives became known, giant firms like Bear Stearns and AIG would've defaulted due to credit derivative obligations to counterparties. This would have led, in turn,  to counterparty failure of many giants in the world banking system. The Federal Reserve decided early on to bail out Bear Stearns credit derivative losses, and the first $70 billion given to AIG by Hank Paulsen in the new Bailout Bill went to pay off AIG's counterparties to AIG's credit derivative contracts --- http://www.trinity.edu/rjensen/2008Bailout.htm#SEC

    So what is a derivative financial instrument? Consider first a financial debt instrument that historically was a contract in which a borrower borrowed money from a lender and the risk for the entire notional (the loan principal) passed from borrower to lender. For example, if Company B sold bonds for $100 million to Company C, the entire notional ($100 million) is at risk of being paid back to Company B. Credit rating companies, in turn, rate those bonds as to financial risk with such ratings as AAA (virtually certain to be paid back) all the way down to junk bonds (very high risk of default) of the entire notional amount. Credit ratings greatly impact the price received by Company B for its bond sales.

    A derivative financial instrument is similar except that the notional amount is often not at risk because these contracts "net settle." For example, if Airline A enters into futures contracts to buy a million gallons of jet fuel one year from now at a forward price of $4 per gallon, the notional full value of a million gallons of fuel never changes hands. After a year passes, Airline A net settles with the counterparties on the net difference between the current spot price and the contracted forward price. Although in some cases a purchase/sale contract can specify physical delivery of the notional, most derivative contracts net settle without putting the entire notional amount at risk.

    Hence, a derivative financial instrument has a notional (a quantity such a a million bushels of corn), an underlying (such as the market price of a particular grade of corn), and net settlement provisions that do not put the value of the entire notional amount at risk. Only the difference between forward and spot prices on the notional is at risk. The entire notional becomes at risk only if the future spot prices fall to zero or nearly zero. This is not likely to happen in the case of commodities like corn, oil, copper, gold, silver, etc. It can happen in the case of credit ratings where $100 million in AAA bonds fall to zero when the debtor is declared to be hopelessly bankrupt. This is why credit derivatives are much more risky than commodity derivatives. If a credit derivative is written on a $100 million bond contract, the entire $100 million might be lost. The probability of losing the entire value of the notional is much greater with credit derivatives than with commodities that are almost certain not to decline to $0 in value.

    The underlying is generally called an index. Examples include corn prices, oil prices, interest rates (e.g., Treasury rates or LIBOR rates), and credit ratings (AAA, AAB, BBB, etc.). A huge difference between commodity versus credit derivatives lies in the depth (number of buyers and sellers) and the frequency of trades in the market. For example, in the derivatives markets for corn futures or corn options (puts and calls) there are thousands upon thousands of buyers and sellers and the market prices (e.g., futures, option, and spot prices) change by the minute each trading day. In the case of a credit derivative written on the bond rating by a credit rating agency there is no deep market and the credit rating rarely changes. There is no underlying "market" in the case of a credit derivative. Hence a credit derivative differs fundamentally from a commodity derivative in the depth of the market and the frequency of trading on the market. Its a mistake to lump credit derivatives and commodity derivatives in the same a single type of contracting called derivatives.

    By any other name, a credit derivative is an insurance contract where risk of default is not market based but depends upon some disaster just like casualty insurance protects against such disasters as fire, wind, and flood. The entire value of the notional (the entire value of each bond insured for credit risk or each house insured for fire loss) is at risk.

    In contrast, a commodity derivative is market based and does not in general put the the entire notional at risk because commodity values are not likely to be wiped out entirely. Commodities may move up and down in value, thereby generating variations in the basis (which is the difference between spot and forward prices), but it would be extremely rare for the a commodity to fall to zero in value. It is much more common for an insured house to be burned down entirely or an insured (with a credit derivative) bond notional to fall into junk bond status.

    AIG and Allstate and State Farm are required by insurance laws to have capital reserves to cover a large number of houses burning down at the same time. However, if all insured houses burned down at the same time, insurance companies could not possibly cover all the losses. This is why a single insurance company might refuse to insure more than a certain percentage of houses in a give geographic area. Insurance written above a company's limit is spread to other companies by a process called reinsurance. Insurance companies are subject to regulation that requires capital reserves to cover actuary-determined expected losses and contract clauses that limit risk in case of catastrophes such as nuclear holocaust.

    Credit derivative insurers could not write insurance contracts for credit default without capital reserves and other catastrophe clauses until Congress in Year 2000 allowed investment banks like Bear Stearns and insurance underwriters like AIG to enter into credit derivative insurance without capital reserves and catastrophe clauses. The fraudulent sub-prime loan market became a catastrophe in terms of real estate loans covered against default by credit derivatives. Bear Stearns, AIG, and the other credit derivative underwriters had insufficient capital reserves and would've defaulted on their credit derivatives if the U.S. government had not stepped in to cover amounts owed to credit derivative counterparties. The government justified bailing out these obligations by stating that the domino effect would've otherwise brought down the entire banking system. On this I'm a cynic, but that's another matter entirely. History is history at this point.

    What is sad today is that derivatives in general are getting a bad name!
    Commodity derivatives (including interest rate risk derivatives) are great vehicles for managing financial risk provided the commodities and their derivatives are both traded in deep markets with virtually zero probability that commodity values will fall to zero. Sadly, most people in the world just do not appreciate the importance of maintaining active commodity derivative markets for managing risk.

    Ignorant people, especially ignorant members of congress, may move to ban or severely restrain all derivative markets rather than to merely reclassify credit derivatives as insurance contracts subject to insurance laws. This does not mean, however, that I think that commodity derivative contracting should be more regulated for protection against unscrupulous sellers of derivative contracts. Like my hero Frank Partnoy, I've argued for years that there should be more regulation of sellers of derivative contracts.

    I have a detailed history of derivative instrument contract scandals and the evolution of accounting rules (national and international) for derivative contracts at http://www.trinity.edu/rjensen/FraudCongress.htm#DerivativesFrauds
    At each point in the way I've applauded Frank Partnoy's appeal for both expanded use of derivative instruments for managing risk and expanded regulations to stop firms like Merrill Lynch, Morgan Stanley, and other unscrupulous outfits from writing derivatives with built-in financial complexity intended to obscure risk and screw fund investors who did not understand what they were buying into.

    Bob Jensen's free tutorials and videos on complex accounting rules for accounting for derivative financial instruments and hedging activities --- http://www.trinity.edu/rjensen/caseans/000index.htm

    Bob Jensen's glossary on derivative financial instruments --- http://www.trinity.edu/rjensen/acct5341/speakers/133glosf.htm

    If Greenspan Caused the Subprime Real Estate Bubble, Who Caused the Second Bubble That's About to Burst?
    Answer:  See http://www.trinity.edu/rjensen/2008Bailout.htm#LiquidityBubble

     

    1980
    Although the Nobel Prize winning work of Merton, Scholes, and Black received the Nobel Prize for the Black-Scholes Options Pricing Model published in 1973, mention should be made of this seminal, albeit controversial, model used in valuation of derivative financial instruments --- http://en.wikipedia.org/wiki/Black%E2%80%93Scholes
    The term Black–Scholes refers to three closely related concepts:
    • The Black–Scholes model is a mathematical model of the market for an equity, in which the equity's price is a stochastic process.
    • The Black–Scholes PDE is a partial differential equation which (in the model) must be satisfied by the price of a derivative on the equity.
    • The Black–Scholes formula is the result obtained by solving the Black-Scholes PDE for European put and call options.

    Robert C. Merton was the first to publish a paper expanding the mathematical understanding of the options pricing model and coined the term "Black-Scholes" options pricing model, by enhancing work that was published by Fischer Black and Myron Scholes. The paper was first published in 1973. The foundation for their research relied on work developed by scholars such as Louis Bachelier, A. James Boness, Sheen T. Kassouf, Edward O. Thorp, and Paul Samuelson. The fundamental insight of Black-Scholes is that the option is implicitly priced if the stock is traded.

    Merton and Scholes received the 1997 Nobel Prize in Economics for this and related work. Though ineligible for the prize because of his death in 1995, Black was mentioned as a contributor by the Swedish academy.

    Also see "Optimal Liquidation of Assets in the Presence of Personal Taxes: Implications for Asset Pricing," by Myron Scholes and  George Constantinides, Journal of Finance, Vol. 35, No. 2,1980.


    1980
    United Nations Intergovernmental Working Group on Accounting and Reporting met for first time. The International Accounting Standards Committee (IASC) presents position paper on co-operation. This was an important early step toward the internationalization of accounting standards which at the time were over 100 sets of differing standards in over 100 nations.

    The  IASC eventually was upgraded to the International Accounting Standards Board (IASB) in 2001 --- http://en.wikipedia.org/wiki/International_Accounting_Standards_Board
    The IASB homepage is at http://www.iasb.org/Home.htm

    Chronology of IFRS standards --- http://www.iasplus.com/restruct/chrono.htm


    1980
    "Forecasting financial derivative prices," by  I. Antoniou, A, B, Yu. S. Gorshkovc, V. V. Ivanova, d and A. V. Kryaneva, C, , Chaos, Solitons & Fractals Volume 11, 1980, Pages 223-229

    In this paper we consider the problem of forecasting the prices of financial market derivatives. A model of changing the underlying asset prices in the form of general Ito stochastic process is developed. The derivative prices can be obtained from the solution of the reverse Cauchy problem for appropriate parabolic equations on the basis of the reverse Kolmogorov equation. We present here the numerical scheme for solving the reverse Cauchy problem for call option and put option prices based on the implicit finite element difference method.

    Article Outline 1. Introduction 1.1. Generalization of Black–Scholes equation 2. Numerical scheme for the solution of the generalized Black–Scholes equation 3. Appendix: the reverse Kolmogorov equation Conclusion Acknowledgements References

    Also see "Empirical Properties of the Black-Scholes Formula Under Ideal Conditions", by M. Bhattacharya, Journal of Financial and Quantitative Analysis, Vol. 15, 1980, pp.1081-1105


    1980
    Jensen Comment
    Among other things, the Black-Scholes model played heavily on one of the largest scandals ever to hit Wall Street. See the Long Term Capital Management scandal under year 2004 below.


    1980
    Depository Institutions and Deregulation Money Control Act of 1980 --- http://en.wikipedia.org/wiki/Depository_Institutions_and_Deregulation_Money_Control_Act

    Some of the many, many lawsuits settled by auditing firms can be found at http://www.trinity.edu/rjensen/Fraud001.htm

    1981
    The United States Financial Accounting Standards Board (FASB) Technical Bulletin 81-1 was issued in February 1981 to provide guidance for disclosure of accounting policies for futures contracts and certain other contracts, but it did not discuss forward contracts or swaps that are portfolios of forward contracts. Interest rate swaps that are so popular in the 21st Century for managing cash and hedging interest rate risks had not even been invented until 1981.

    1981
    "SEC May Police Fair-Value Pricing," by Tom Lauricella, The Wall Street Journal, April 26, 2004 ---
    http://online.wsj.com/article/0,,SB108292923140792834,00.html?mod=home%5Fwhats%5Fnews%5Fus

    Agency Is Weighing Move To Take Disciplinary Action Against Errant Fund Firms

    The Securities and Exchange Commission for the first time is weighing bringing disciplinary actions against mutual-fund companies that have failed to use so-called fair-value pricing for portfolio holdings with out-of-date market prices, agency officials said.

    The SEC investigations into fair-value pricing practices at an undisclosed number of fund companies are still in the preliminary stages, the officials cautioned. But any resulting disciplinary efforts would open another front in the SEC's expanded scrutiny of the fund industry and signal that the agency is attaching greater importance to fair-value techniques in the wake of the share-trading scandal.

    Fair-valuation practices involve using estimates to set the value of portfolio holdings when the securities' closing market prices become out of date because of later developments. Such mispricing is particularly an issue for U.S. mutual funds holding foreign stocks whose closing values are hours old by the time the funds calculate their share prices at the end of trading for U.S. markets. Funds using such out-of-date prices have been targets of market timers, who are short-term traders who profit by rapidly buying and selling fund shares to the detriment of long-term fund investors.

    The SEC approved fair-value techniques in 1981 and strongly recommended funds use them, but the agency never directly required funds to adopt such pricing methods. However, under other SEC rules, funds have an obligation to make sure their share prices are as accurate as possible after events such as major swings in U.S. markets after the close of overseas stock trading.

    As a result, agency officials said the SEC investigation is focusing on whether funds in such circumstances violated their obligations to set the most accurate share prices possible if they didn't consider using fair-value techniques.

    Some experts think the probe will result in disciplinary charges if a fund didn't consider using fair-value practices. "It wouldn't surprise me to see them bring a case," says Barry Barbarsh, a former top SEC official now at Shearman & Sterling. The notion that the SEC has wanted funds to make greater use of fair-value techniques "has been out there for a while," he said.

    The prospect of new allegations is an added headache for the fund industry that has been enveloped in scandal for seven months because of share-trading abuses as well as cases involving the misuse of investors' money in promoting the sales of funds. Fund companies have already been hit with $1.7 billion in fines and numerous top executives have lost their jobs.

    Continued in article


    1981
    Interest Rate Swaps were invented in 2001 --- http://en.wikipedia.org/wiki/Interest_rate_swap

    These derivative financial instruments are essentially portfolios of forward contracts swapping interest payments (usually fixed versus variable rate payments) were not even required to be disclosed in financial statements of banks and other corporations since there were no accounting rules for forward contracts. In a few years interest rate swaps became popular worldwide for both managing cash and for achieving off-balance-sheet financing --- http://en.wikipedia.org/wiki/Off-balance-sheet


    Shortly after Salamon Brothers invented the interest rate swap financial instruments derivative in a contract between IBM and the World Bank in 1981, this type of derivative was used to manage risk in a copper mining operation in a Mexican company called Mexicana de Cobre (Mexcobre), a subsidiary of a copper mining group in Mexicao called Group Mexico.  The transaction eventually involved ten banks in several nations, a Belgian customer, multiple foreign currencies, and Mexcobre itself.

    Mexcobre Case (a complex international hedging case involving a copper price swap)
    http://www.trinity.edu/rjensen/caseans/133sp.htm
    The Excel spreadsheet is at http://www.trinity.edu/rjensen/caseans/xls/mexcobre/133spans.xls
    Note that this real-life case is not a scandal. It does illustrate how new types of derivative financial instruments were being used for speculation and hedging.


    1981
    "Executive Compensation Taxes and Incentives," by Myron Scholes and Merton Miller,  Financial Economics: Essays in Honor of Paul Cootner, edited by Katherine Cootner and William Sharpe, Prentice-Hall, 1981.

     

    1982
    Garn-St. Germain Depository Institutions Act of 1982 (a disaster) --- http://www.answers.com/topic/garn-st-germain-depository-institutions-act
    Many derivatives transactions entail money market accounts.

    The Savings and Loan Frauds Cost the U.S. Government Billions of Dollars
    From Wikipedia ---

    While not part of the Savings and Loan Crisis, many other banks failed. Between 1980 and 1994 more than 1,600 banks insured by the Federal Deposit Insurance Corporation (FDIC) were closed or received FDIC financial assistance.

    During the Savings and Loan Crisis, from 1986 to 1995, the number of US federally insured savings and loans in the United States declined from 3,234 to 1,645. [15] This was primarily, but not exclusively, due to unsound real estate lending.

    The market share of S&Ls for single family mortgage loans went from 53% in 1975 to 30% in 1990. U.S. General Accounting Office estimated cost of the crisis to around USD $160.1 billion, about $124.6 billion of which was directly paid for by the U.S. government from 1986 to 1996.  That figure does not include thrift insurance funds used before 1986 or after 1996. It also does not include state run thrift insurance funds or state bailouts.

    The concomitant slowdown in the finance industry and the real estate market may have been a contributing cause of the 1990-1991 economic recession. Between 1986 and 1991, the number of new homes constructed dropped from 1.8 to 1 million, the lowest rate since World War II.

    A taxpayer funded government bailout related to mortgages during the Savings and Loan crisis may have created a moral hazard and acted as encouragement to lenders to make similar higher risk loans during the 2007 subprime mortgage financial crisis.

    . . .

    The United States Congress granted all thrifts in 1980, including savings and loan associations, the power to make consumer and commercial loans and to issue transaction accounts. Designed to help the thrift industry retain its deposit base and to improve its profitability, the Depository Institutions Deregulation and Monetary Control Act (DIDMCA) of 1980 allowed thrifts to make consumer loans up to 20 percent of their assets, issue credit cards, accept negotiable order of withdrawal (NOW) accounts from individuals and nonprofit organizations, and invest up to 20 percent of their assets in commercial real estate loans.

    The damage to S&L operations led Congress to act, passing a bill in September 198 allowing S&Ls to sell their mortgage loans and use the cash generated to seek better returns; the losses created by the sales were to be amortized over the life of the loan, and any losses could also be offset against taxes paid over the preceding 10 years. This all made S&Ls eager to sell their loans. The buyers - major Wall Street firms - were quick to take advantage of the S&Ls' lack of expertise, buying at 60%-90% of value and then transforming the loans by bundling them as, effectively, government-backed bonds (by virtue of Ginnie Mae, Freddie Mac, or Fannie Mae guarantees). S&Ls were one group buying these bonds, holding $150 billion by 1986, and being charged substantial fees for the transactions.

    In 1982, the Garn-St Germain Depository Institutions Act was passed and increased the proportion of assets that thrifts could hold in consumer and commercial real estate loans and allowed thrifts to invest 5 percent of their assets in commercial loans until January 1, 1984, when this percentage increased to 10 percent.

    A large number of S&L customers' defaults and bankruptcies ensued, and the S&Ls that had overextended themselves were forced into insolvency proceedings themselves.

    The U.S. government agency Federal Savings and Loan Insurance Corporation (FSLIC), which at the time insured S&L accounts in the same way the Federal Deposit Insurance Corporation insures commercial bank accounts, then had to repay all the depositors whose money was lost. From 1986 to 1989, FSLIC closed or otherwise resolved 296 institutions with total assets of $125 billion. An even more traumatic period followed, with the creation of the Resolution Trust Corporation in 1989 and that agency’s resolution by mid-1995 of an additional 747 thrifts.

    There also were state-chartered S&Ls that failed. Some state insurance funds failed, requiring state taxpayer bailouts.

    The major causes of Savings and Loan crisis according to United States League of Savings Institutions

    The following is a detailed summary of the major causes for losses that hurt the savings and loan business in the 1980s[6]:

    1. Lack of net worth for many institutions as they entered the 1980s, and a wholly inadequate net worth regulation.
    2. Decline in the effectiveness of Regulation Q in preserving the spread between the cost of money and the rate of return on assets, basically stemming from inflation and the accompanying increase in market interest rates.
    3. Absence of an ability to vary the return on assets with increases in the rate of interest required to be paid for deposits.
    4. Increased competition on the deposit gathering and mortgage origination sides of the business, with a sudden burst of new technology making possible a whole new way of conducting financial institutions generally and the mortgage business specifically.
    5. A rapid increase in investment powers of associations with passage of the Depository Institutions Deregulation and Monetary Control Act (the Garn-St Germain Act), and, more important, through state legislative enactments in a number of important and rapidly growing states. These introduced new risks and speculative opportunities which were difficult to administer. In many instances management lacked the ability or experience to evaluate them, or to administer large volumes of nonresidential construction loans.
    6. Elimination of regulations initially designed to prevent lending excesses and minimize failures. Regulatory relaxation permitted lending, directly and through participations, in distant loan markets on the promise of high returns. Lenders, however, were not familiar with these distant markets. It also permitted associations to participate extensively in speculative construction activities with builders and developers who had little or no financial stake in the projects.
    7. Fraud and insider transaction abuses were the principal cause for some 20% of savings and loan failures the past three years and a greater percentage of the dollar losses borne by the Federal Savings and Loan Insurance Corporation (FSLIC).
    8. A new type and generation of opportunistic savings and loan executives and owners—some of whom operated in a fraudulent manner — whose takeover of many institutions was facilitated by a change in FSLIC rules reducing the minimum number of stockholders of an insured association from 400 to one.
    9. Dereliction of duty on the part of the board of directors of some savings associations. This permitted management to make uncontrolled use of some new operating authority, while directors failed to control expenses and prohibit obvious conflict of interest situations.
    10. A virtual end of inflation in the American economy, together with overbuilding in multifamily, condominium type residences and in commercial real estate in many cities. In addition, real estate values collapsed in the energy states — Texas, Louisiana, Oklahoma particularly due to falling oil prices — and weakness occurred in the mining and agricultural sectors of the economy.
    11. Pressures felt by the management of many associations to restore net worth ratios. Anxious to improve earnings, they departed from their traditional lending practices into credits and markets involving higher risks, but with which they had little experience.
    12. The lack of appropriate, accurate, and effective evaluations of the savings and loan business by public accounting firms, security analysts, and the financial community.
    13. Organizational structure and supervisory laws, adequate for policing and controlling the business in the protected environment of the 1960s and 1970s, resulted in fatal delays and indecision in the examination/supervision process in the 1980s.
    14. Federal and state examination and supervisory staffs insufficient in number, experience, or ability to deal with the new world of savings and loan operations.
    15. The inability or unwillingness of the Bank Board and its legal and supervisory staff to deal with problem institutions in a timely manner. Many institutions, which ultimately closed with big losses, were known problem cases for a year or more. Often, it appeared, political considerations delayed necessary supervisory action.

     

    Some of the many, many lawsuits settled by auditing firms can be found at http://www.trinity.edu/rjensen/Fraud001.htm

    The Timeline of the Recent History of Fannie Mae Scandals 2002-2008 --- http://www.trinity.edu/rjensen/caseans/000index.htm#FannieMae
    "Fannie Mayhem: A History," The Wall Street Journal, July 14, 2008
     

    1983
    IASC Developments
    Introduction to International Accounting Reporting Standards
    --- http://static.managementboek.nl/pdf/9780471726883.pdf

    IASC entered a new phase in 1987, which led directly to its 2001 reorganization, when the then-Secretary General, David Cairns, encouraged by the US SEC, negotiated an agreement with the International Organization of Securities Commissions (IOSCO). IOSCO was looking for a common international “passport” with which companies could be accepted for a secondary listing in the jurisdiction of any IOSCO member. The concept was that, whatever the listing rules in a company’s primary stock exchange, there would be a common minimum package which all stock exchanges would accept from foreign companies seeking a secondary listing. IOSCO was prepared to use IFRS as the financial reporting basis for this passport, provided that the international standards could be brought up to the level IOSCO stipulated. For the first time, the IASC would have a clear client and a clear role for its standards.

    Historically, a major criticism of IFRS was that it essentially endorsed all accounting methods then in wide usage, effectively becoming a “lowest common denominator” set of standards. The trend in national GAAP was to narrow the range of acceptable alternatives, although uniformity was not anticipated in the near term. The IOSCO agreement provoked frenetic activity to improve the existing standards by removing the many alternative treatments which were permitted under the standards. The IASC launched its comparability and improvements project to develop a “core set of standards” as demanded by IOSCO. These were complete by 1993, not without disagreements between members, but—to the great frustration of the IASC—were then not accepted by IOSCO. IASC leaders were unhappy, amongst other things, that IOSCO seemingly wanted to cherry-pick individual standards, rather than endorse the IASC’s process and thus all the standards created thereby.

    Ultimately, the collaboration was relaunched in 1995, with IASC under new leadership, and this began a further frenetic period where existing standards were again reviewed and revised, and new standards were created to fill perceived gaps. This time the set of standards included, amongst others, IAS 39, on recognition and measurement of financial instruments, which had been accepted, at the very last moment and with great difficulty, as a compromise, purportedly interim standard.

    At the same time, the IASC had established a committee to contemplate its future structure. In part, this was the result of pressure exerted by the US SEC and the US private sector standard setter, the FASB, which were seemingly concerned that IFRS were not being developed by “due process.” While there may have been other agendas by some of the parties (the FASB, for example, was opposed to IFRS at the time and hoped that US GAAP would instead be accepted by other nations), in fact the IFRS were in need of strengthening, particularly as to reducing the range of diverse but accepted alternatives for similar transactions and events.

    If IASC was to be the standard setter endorsed by the world’s stock exchange regulators, it would need a structure that reflected that level of responsibility. The historical Anglo- Saxon standard-setting model—where professional accountants set the rules for themselves— had largely been abandoned in the twenty-five years since the IASC was formed, and standards were mostly being set by dedicated and independent national boards such as the FASB, and not by profession-dominated bodies like the AICPA. The choice, as restructuring became inevitable, was between a large, representative approach—much like the existing IASC structure, but where national standard setters sent representatives—or a small, professional body of experienced standard setters which worked independently.

    The end of this phase of the international standard setting, and the resolution of these issues, came about within a short period in 2000. In May, IOSCO members voted at their annual meeting to endorse IASC standards, albeit subject to a number of reservations (see discussion later in this chapter). This was a considerable step forward for the IASC, which was quickly surpassed by an announcement in June 2000 that the European Commission intended to adopt IFRS as the requirement for primary listings in all member states. This planned full endorsement by the EU eclipsed the less than enthusiastic IOSCO announcement, and since then the EU has appeared to be the more influential body as far as gaining acceptance for IFRS is concerned.

    In July 2000, IASC members voted to abandon the old structure based on professional bodies and adopt a new structure: beginning in 2001, standards would be set by a professional board, financed by voluntary contributions raised by a new oversight body.

    Continued in article


    Some of the many, many lawsuits settled by auditing firms can be found at http://www.trinity.edu/rjensen/Fraud001.htm
     

    1984
    In August 1984 the United States Financial Accounting Standards Board (FASB) issued FAS 80 which in 1999 was subequently replaced by FAS 133. Where as FAS 133 covers wide ranging types of derivative financial instruments (including forward contracts and swaps), FAS 80 was largely based on derivatives that initial cash flows (premiums) such as purchased and sold (written) options. It also covered futures contracts since futures contracts settle daily in cash, FAS 80 did not require booking or even disclosures of forward contracts and swaps (that are generally portfolios of forward contracts).--- http://www.fasb.org/pdf/fas80.pdf

    FAS 80 required that options be recorded at historical cost and amortized over the life of each option. Options were not adjusted for fair value and often had values far different than amortized cost. Futures contracts were adjusted daily to fair value because they are settled daily for changes in fair value on organized futures market exchanges. Special rules applied to options and futures deemed qualified for hedge accounting.


    1984
    Insider Trading Sanctions Act --- http://www.answers.com/Insider+Trading+Sanctions+Act?cat=biz-fin
    This law extended the jurisdiction of the SEC into illegal acts of trading in financial instruments and derivative financial instruments.

    Some of the many, many lawsuits settled by auditing firms can be found at http://www.trinity.edu/rjensen/Fraud001.htm

    1985
    Alternative (conventional accounting) rules may, for the individual citizen, mean the difference between employment and unemployment, reliable products and dangerous ones, enriching experiences and oppressive ones, stimulating work environments and dehumanising ones, care and compassion for the old and sick versus intolerance and resentment.
    Tony Tinker, 1985

    1985
    Infectious Greed:  How Deceit and Risk Corrupted the Financial Markets
      (Henry Holt and Company, 2003, Page 17, ISBN 0-8050-7510-0)

    In February 1985, the United States Financial Accounting Standards Board (FASB) --- the private group that established most accounting standards (in the U.S.) --- asked whether banks should begin including swaps on their balance sheets, the financial statements that recorded their assets and liabilities . . .since the early 1980s banks had not included swaps as assets or liabilities . . . the banks' argument was deeply flawed. The right to receive money on a swap was a valuable asset, and the obligation to pay money on a swap was a costly liability.

    But bankers knew that the fluctuations in their swaps (swap value volatility) would worry their shareholders, and they were determined to keep swaps off their balance sheets (including mere disclosures as footnotes), FASB's inquiry about banks' treating swaps as off-balance-sheet --- a term that would become widespread during the 1991s --- mobilized and unified the banks, which until that point had been competing aggressively and not cooperating much on regulatory issues. All banks strongly opposed disclosing more information about their swaps, and so they threw down their swords and banded together a serveral high-level meetings.

    Some of the many, many lawsuits settled by auditing firms can be found at http://www.trinity.edu/rjensen/Fraud001.htm

    1986
    "Jury Finds Former Insurance Executives Guilty," The New York Times, February 25, 2008 ---
    http://www.nytimes.com/aponline/us/AP-CT-GenRe-AIGTrial.html

    A Connecticut jury found five former insurance company executives guilty Monday of a scheme to manipulate the financial statements of the world's largest insurance company.

    The verdict came in the seventh day of jury deliberations following a month long trial in federal court.

    The defendants, four former executives of General Re Corp. and a former executive of American International Group Inc., sat stone-faced as the verdict was read. They were accused of inflating AIG's (NYSE:AIG) reserves through reinsurance deals by $500 million in 2000 and 2001 to artificially boost its stock price.

    The defendants were former General Re CEO Ronald Ferguson; former General Re Senior Vice President Christopher P. Garand; former General Re Chief Financial Officer Elizabeth Monrad; and Robert Graham, a General Re senior vice president and assistant general counsel from about 1986 through October 2005.

    Jensen Comment
    The above manipulations entailed more than derivative financial instruments, but derivatives in the so-called "finite-risk transactions" were structured and treated on the financial statements were part of the problem. Following the SEC request for information, General Re lawyers combed through their finite-risk insurance deals and turned up roughly a dozen transactions where it wasn't clear that enough risk had been transferred to treat them as insurance. AIG cooperated fully with the SEC in this probe.


    1986
    "Insolvent abuse:  Insolvency practitioners often charge huge fees, leaving less money for the creditors. It's time this industry was properly regulated," by Prem Sikka, The Guardian, April 14, 2008 --- http://commentisfree.guardian.co.uk/prem_sikka_/2008/04/insolvent_abuse.html

    The current economic turmoil is expected to lead to a steep rise in business and personal bankruptcies. Millions of innocent people will lose their jobs, homes, savings, pensions and investments. The bad news for millions is a boon for corporate undertakers, also known as insolvency practitioners, who are poorly regulated, lack effective public accountability and indulge in predatory practices.

    Following the Insolvency Act 1986, all UK personal and business insolvencies must be handled by just 1,600 insolvency practitioners belonging to law and accountancy trade associations. They are regulated by no fewer than seven self-interested groups rather than by any independent regulator, leaving plenty of scope for duplication, waste and buck-passing.

    Over half of all insolvency practitioners work for the big four accountancy firms. Within accountancy firms, insolvency work is treated as a profit centre and employees are under constant pressure to generate new business. Capitalism provides its own victims, but profitable opportunities are also manufactured by practitioners.

    Jensen Comment
    Although not dealing with derivative financial instruments per se, the use of auditors as insolvency practitioners in the United Kingdom illustrates potential conflicts of interest that the auditing profession seems to tolerate --- http://www.trinity.edu/rjensen/Fraud001.htm#Professionalism

    Some of the many, many lawsuits settled by auditing firms can be found at http://www.trinity.edu/rjensen/Fraud001.htm

    1987
    Infectious Greed:  How Deceit and Risk Corrupted the Financial Markets  (Henry Holt and Company, 2003, Page 17, ISBN 0-8050-7510-0)

    As 1987 began, Andy Krieger (at Salomon Brothers and doing currency trading through Bankers Trust) found what he believed was an incredible opportunity to make money trading currency options The U.S. Federal Reserve and various central banks in Europe had implemented policies to maintain their currencies within a stable zone. The dollar had been falling for several years, but during 1987 it stabilized, and by the fall of 1987 the volatility numbers traders were using to evaluate currency options were very low. As a result, currency options were incredibly cheap . . . If these (currency trading banks) had been buying and selling stocks instead of currencies, such efforts to move short-term prices would have constituted "market manipulation." But currency markets were unregulated free-for-all, where manipulative trading tactics were quite common and perfectly legal. By manipulating prices, a trader might be able to generate profits even if the markets were quite efficient. This was something academics studying financial markets hadn't yet considered. And it was something the traders loved to do.

    Manipulative practices were especially common in the over-the-counter markets --- the wild Wild West of trading. Instead of buying and selling options on a centralized exchange, which acted as a counterparty to all trades, traders could enter into private contracts with buyers and selliers, typically other banks . . . The exchanges monitored manipulative practices but nobody watched the over-the-counter traders.

    In one infamous episode, Krieger sold, or shorted, roughly the entire money supply of New Zealand. He also held call options --- of similar amounts --- which benevit if the kiwi went up, and therefore woudl offset any losses from his short position . . . Krieger's stragegy drew from one of the central insights of modern finance, generally known as parity (or put-call parity), and it is worth taking a few minutes to contemplate --- http://en.wikipedia.org/wiki/Put-call_parity

    . . .

    Currency-options traders were shocked, and trading currency options nearly halted for a few hours before Krieger resigned. Again, rumors swirled about Krieger's resignation, including word that Banker Trust had incurred huge losses in currency options, perhas as mch as $100 million. A spokesman denied the rumors, the the denial only fed speculation about what had happened at Bankers Trust.


    1987
    IASC Developments
    Introduction to International Accounting Reporting Standards
    --- http://static.managementboek.nl/pdf/9780471726883.pdf

    IASC entered a new phase in 1987, which led directly to its 2001 reorganization, when the then-Secretary General, David Cairns, encouraged by the US SEC, negotiated an agreement with the International Organization of Securities Commissions (IOSCO). IOSCO was looking for a common international “passport” with which companies could be accepted for a secondary listing in the jurisdiction of any IOSCO member. The concept was that, whatever the listing rules in a company’s primary stock exchange, there would be a common minimum package which all stock exchanges would accept from foreign companies seeking a secondary listing. IOSCO was prepared to use IFRS as the financial reporting basis for this passport, provided that the international standards could be brought up to the level IOSCO stipulated. For the first time, the IASC would have a clear client and a clear role for its standards.

    Historically, a major criticism of IFRS was that it essentially endorsed all accounting methods then in wide usage, effectively becoming a “lowest common denominator” set of standards. The trend in national GAAP was to narrow the range of acceptable alternatives, although uniformity was not anticipated in the near term. The IOSCO agreement provoked frenetic activity to improve the existing standards by removing the many alternative treatments which were permitted under the standards. The IASC launched its comparability and improvements project to develop a “core set of standards” as demanded by IOSCO. These were complete by 1993, not without disagreements between members, but—to the great frustration of the IASC—were then not accepted by IOSCO. IASC leaders were unhappy, amongst other things, that IOSCO seemingly wanted to cherry-pick individual standards, rather than endorse the IASC’s process and thus all the standards created thereby.

    Ultimately, the collaboration was relaunched in 1995, with IASC under new leadership, and this began a further frenetic period where existing standards were again reviewed and revised, and new standards were created to fill perceived gaps. This time the set of standards included, amongst others, IAS 39, on recognition and measurement of financial instruments, which had been accepted, at the very last moment and with great difficulty, as a compromise, purportedly interim standard.

    At the same time, the IASC had established a committee to contemplate its future structure. In part, this was the result of pressure exerted by the US SEC and the US private sector standard setter, the FASB, which were seemingly concerned that IFRS were not being developed by “due process.” While there may have been other agendas by some of the parties (the FASB, for example, was opposed to IFRS at the time and hoped that US GAAP would instead be accepted by other nations), in fact the IFRS were in need of strengthening, particularly as to reducing the range of diverse but accepted alternatives for similar transactions and events.

    If IASC was to be the standard setter endorsed by the world’s stock exchange regulators, it would need a structure that reflected that level of responsibility. The historical Anglo- Saxon standard-setting model—where professional accountants set the rules for themselves— had largely been abandoned in the twenty-five years since the IASC was formed, and standards were mostly being set by dedicated and independent national boards such as the FASB, and not by profession-dominated bodies like the AICPA. The choice, as restructuring became inevitable, was between a large, representative approach—much like the existing IASC structure, but where national standard setters sent representatives—or a small, professional body of experienced standard setters which worked independently.

    The end of this phase of the international standard setting, and the resolution of these issues, came about within a short period in 2000. In May, IOSCO members voted at their annual meeting to endorse IASC standards, albeit subject to a number of reservations (see discussion later in this chapter). This was a considerable step forward for the IASC, which was quickly surpassed by an announcement in June 2000 that the European Commission intended to adopt IFRS as the requirement for primary listings in all member states. This planned full endorsement by the EU eclipsed the less than enthusiastic IOSCO announcement, and since then the EU has appeared to be the more influential body as far as gaining acceptance for IFRS is concerned.

    In July 2000, IASC members voted to abandon the old structure based on professional bodies and adopt a new structure: beginning in 2001, standards would be set by a professional board, financed by voluntary contributions raised by a new oversight body.

    Continued in article


    Some of the many, many lawsuits settled by auditing firms can be found at http://www.trinity.edu/rjensen/Fraud001.htm

    1988
    Infectious Greed:  How Deceit and Risk Corrupted the Financial Markets
      (Henry Holt and Company, 2003, Page 219, ISBN 0-8050-7510-0)

    In 1988, Morgan Stanley created a security called PERCS, based on the more conservative piece of the Americus Trust dels. PERCS stood for "Preferred Equity-Redemption Cumulative Stock," and resembled a preferred stock, with cumulative dividends that were higher than the dividends paid on common stock . . . The key twist was that, in three years, PERCS automatically converted into common stock, according to a specified stock if the common stock was at $50, so as to limit the upside of PERCS. Essentially, an investor buying PERCS committed to buy a company's stock in three years, and also sold some of the upside potential of that stock by selling a three-year call option (similar to those Andy Krieger was trading at Bankers Trust). The company bought the three-year call option from the investor, and paid the investor a "premium" in the form of a cumulative dividend for three years.

    1988
    Infectious Greed:  How Deceit and Risk Corrupted the Financial Markets  (Henry Holt and Company, 2003, Page 67, ISBN 0-8050-7510-0)

    There were two major innovations at First Boston (under Allen Wheat) during the early 1990s. One involved structured notes --- essentially, highly rated bonds whose payments were linked to the same types of formulas Bankers Trust had used in its complex swaps with Gibson Greeting Cards and Proctor and Gamble . . . The other innovation related to structured finance --- a class of deals in which financial assets were repackaged to obtain higher credit ratings. Within a decade structured finance would become a trillion-dollar industry, ranging from legitimate deals that enabled institutions to transfer risk more efficiently, to more dubious transactions (including those later involved in the collapse of Enron).

    . . .

    Although structured notes were profitable for banks at first, just as complex swaps had been, inevitably the business became more competitive and margins declined. To maintain their profit margins, bankers needed to einvent new versions of the notes, (unbelievably complex) new structures that could not easily be copied, with margins that would last.

    James M. Mahoney, writing in the Federal Reserve Bank of New York Economic Policy REview, put the issue clearly:

    Some individuals and institutions use derivative securities to circumvent (sometimes self-imposed) restrictions on holdings. For instance, the investment committeee of a pension fund or insurance company may requre all investments to be denominated in the domestic currency. While this rule would prohibit direct foreign capital market holdings, the managers of these investment could gain exposure to foreign debt or equity markets through correlation products such as diff swaps or quanto swaps.

    1988
    The December 1998 issue of the Journal of Accountancy provides an interesting contrast on fair value accounting.  On Pages 12-13 you will find a speech by SEC Chairman Arthur Levitt bemoaning the increasingly common practice of auditors to allow earnings management.  On Page 20 you will find a review of an Eighth Circuit Court of Appeals case in which a firm prevented the reporting of net losses for 1988 and 1989 by persuading its auditor to allow reclassification of a large a large hotel as being "for sale" so that it could revalue historical cost book value to current exit value and record the gain as current income.  Back issues of the Journal of Accountancy are now online at
    http://www.aicpa.org/pubs/jofa/joaiss.htm .

    Some of the many, many lawsuits settled by auditing firms can be found at http://www.trinity.edu/rjensen/Fraud001.htm

    1989
    Origins of Consulting Divisions of Public Accounting Firms:  Andersen Consulting Formed in 1989

    Public accounting firms did consulting, especially tax consulting, beginning in the 1900s and even earlier. But the advent of computers gave rise to entirely new opportunities to assist companies with design, installation, and operation of computing systems that replaced manual systems, especially manual accounting systems. In the early 1950s nobody gave much thought to possible violations of independence when public accounting firms audited systems that their consultants helped install and implement. In reality, the systems consultants were from divisions of large offices and did not even communicate with the auditors of local offices even though technically both the consultants and the auditors did work for the same firms. One of the earliest consulting jobs took place in 1953 when General Electric approached one of the Big Eight accounting firms, Arthur Andersen, and "automating payroll processing and manufacturing at GE's Appliance Park facility near Louisville, Kentucky. Arthur Andersen recommended installation of a UNIVAC I computer and printer, and GE agreed, which is the start of what became the first-ever commercial computer in the United States" --- http://en.wikipedia.org/wiki/Andersen_Consulting#Formation_and_early_years

    Between 1953 and 1980 consulting divisions were formed in most public accounting firms, and the majority of the consulting of these firms, apart from age-old tax consulting in their tax divisions, was in the area of automated accounting information systems. Andersen Consulting in 1989 was the first division of a large firm to become a separate corporation owned by the partners of the Arthur Andersen accounting firm. In the early days the managers in charge of the consulting division were called "principals" rather than partners since most were computer experts who were not Certified Public Accountants.

    Beginning in the 1980s and most certainly in the 1991s the consulting divisions of public accounting firms added new types of experts to their consulting divisions. These experts were economists and financial investing experts who assisted clients with financing, speculating, and hedging. Whereas consulting in computer and related information systems was beginning to place auditing independence in jeopardy, financial consulting really increased the risk of violating auditor independence. One of the Big Eight accounting firms, Coopers & Lybrand, had an enormously popular consulting operating for insurance actuaries.

    One of the huge problems was the explosive growth in consulting revenues in the accounting firms. For example, in the 1990s Enron's audit firm, the Houston Office of Arthur Andersen, increased consulting operations to a point where the office was receiving as much or more revenue from Enron's consulting as it was from Enron's auditing. In 2001 just before Enron declared bankruptcy the consulting revenues to the Houston Office and the auditing revenues to the Houston office were each about $25 million per year.

    By the end of the 1990s consulting operations were much more profitable to many large public accounting firms that were the audits even though the audits still brought in more revenue. The problem with audits is that they were more like competitive and fungible commodities where clients could easily change auditors having lower fees without major negative consequences. Bit consulting jobs, in contrast, were often contracted for years into the future and could not so easily be terminated. The advantage of consulting was the enormous markups of prices relative to costs that were scandalous in some instances when clients, including government agencies, became dependent upon the accounting firm consultants for financing and information system design and maintenance. Relations between accounting firm "partners" and consulting division "principals" became fevered in some instances, most notably in the firm of Arthur Andersen. "By 2000, Andersen Consulting had achieved net revenues exceeding US$9.5 billion and had more than 75,000 employees in 47 countries, whereas Arthur Andersen had revenues of US$9.3 billion with over 85,000 employees worldwide in 2001" --- http://en.wikipedia.org/wiki/Andersen_Consulting#Formation_and_early_years

    In August 2000 Andersen Consulting acrimoniously, albeit profitably, severed all ties with the Andersen accounting firm. On January 1, 2000 the "Andersen" name was removed when Andersen Consulting Corporation renamed itself "Accenture" --- http://en.wikipedia.org/wiki/Andersen_Consulting

    The Enron Scandal revealed later in 2001 more than any other single happening led to the 2002 Sarbanes-Oxley Law (SOX) and earlier fevered negative publicity about lack of independence and professionalism in public accounting firm auditing, that most large accounting firms other than Deloitte severed ties with their consulting divisions. Even before SOX KPMG sold its consulting division that eventually became known as BearingPoint --- http://en.wikipedia.org/wiki/BearingPoint
    Ernst & Young sold its consulting division to the French information services company Cap Gemini for $11 billion, largely in stock, creating the new consulting firm of Cap Gemini --- http://en.wikipedia.org/wiki/Ernst_%26_Young_LLP
    PricewaterhouseCoopers (PwC) divestitures were more complicated --- http://en.wikipedia.org/wiki/PwC

    PwC announced in May 2002 that its consulting activities would be spun off as an independent entity. An outside consultancy, Wolff Olins, was hired to create a brand image for the new entity, called "Monday". The firm's CEO, Greg Brenneman described the unusual name as "a real word, concise, recognizable, global and the right fit for a company that works hard to deliver results." These plans were soon revised, however. In October 2002, PricewaterhouseCoopers sold the consultancy business to IBM for approximately $3.9 billion in cash and stock.

    PwC also has developed several broader consulting initiatives in the Enterprise Risk Management (ERM) framework, including a global effort to assist corporations with outsourcing, as well as a global political risk assessment with the political risk advisory firm Eurasia Group.

    Advisory services offered by PwC also include two actuarial consultancy departments; Actuarial and Insurance Management Solutions (AIMS) and a sub branch of "Human Resource Services" (HRS). Actuarial covers mainly 4 areas: pensions, life insurance, non-life insurance and investments. AIMS deals with life and non-life insurance and investments while HRS deals mainly with pensions.

    PwC serves the U.S. Federal Government through their Washington Federal Practice (WFP). PwC has over 2000 professionals based in the Washington Metro Corridor

    Having noted all this, I should mention that auditors still have unique access to financial, accounting, and information technology divisions of audit clients. In spite of the formal divestitures of consulting divisions, consulting has crept (more like soared) back into auditing firms that in recent years compete directly with the older consulting divisions previously sold off. Independence and professionalism after SOX remains as large or even larger problem today. Issues and evidence along these lines can be found at the following two links:

    I particularly mention the coziness between consulting and auditing, because it was auditors in the Andersen auditing firm's Houston Office that helped Enron design the thousands of Special Purpose Entities (SPEs) that these same auditors later audited. These were the same SPEs that allowed Enron's CFO, Andy Fastow, to steal over $30 million from Enron itself as well as deceive investors and creditors --- http://www.trinity.edu/rjensen//theory/00overview/speOverview.htm
    These SPEs were designed by the auditors themselves in Andersen's Houston Office and had nothing to do with the Andersen Consulting division out of Chicago. In the earlier days consultants at least came from different divisions than the auditors. The last shred of auditor independence disappeared in Andersen's audits of Enron.
    See Questions 12-15 at http://www.trinity.edu/rjensen/FraudEnronQuiz.htm
     

    Some of the many, many lawsuits settled by auditing firms can be found at http://www.trinity.edu/rjensen/Fraud001.htm

    1990
    PERLS stands for Principal Exchange Rate Linked Security, so named because the trade's principal repayment is linked to various foreign exchange rates . . .Because PERLS were complex fireign exchange bets packaged to look like simple and safe bonds, they were subject to abuse by chater clients. Although many PERLS looked like bonds issued by a AAA-rated federal agency or company, they actually were option-like bet (on some foreign currency). PERLS were expectially attracctive to devious managers at insurance companies, many of whom wanted to place foreign currency bets with the knowledge of the regulators or their bosses. PERLS were designed to allow such cheater managers to gamble in the volatile foreign exchange futures and options markets.
    Frank Partnoy, Page 51 of Chapter 2 entitled "The House of Cards"
    F.I.A.S.C.O. : The Inside Story of a Wall Street Trader by Frank Partnoy - 283 pages (February 1999) Penguin USA (Paper); ISBN: 0140278796 
    1991
    Infectious Greed:  How Deceit and Risk Corrupted the Financial Markets  (Henry Holt and Company, 2003, Page 77, ISBN 0-8050-7510-0)

    The process of transferring receivables to a new company and issuing new bonds became known as securitization, which became a major part of the structured finance industry . . . One of the most significant innovations in structured finance was a deal called the Collateralized Bond Obligation, or CBO. CBOs are one of the threads that run through the past fifteen years of financial markets, ranging from Michael Milken to First Boston to Enron and WorldCom. CBOs would mutate into various types of credit derivatives --- financial instruments tied to the creditworthiness of companies --- which would play and important role in the aftermath of the collapse of numerous companies in 2001and 2002.

    . . .

    In simple terms, here is how a CBO works. A bank transfers a portfolio of junk bonds to a Special Purpose Entity, typically a newly created company, partnership, or trust domiciled in a balmy tax haven, such as the Cayman Islands. This entity then issues several securities, backed by bonds, effectively splitting the junk bonds into pieces. Investors (hopefully) buy the pieces.

    . . .

    The first CBO was TriCapital Ltc., a $420 million deal sold in July 1988. There were about $900 million CBOs in 1988, and almost $ $3 billion in 1989. Notwithstanding the bad press junk bonds had been getting, analysts from all three of the credit-rating agencies began pushing CBOs. Ther were very profitable for the rating agencies, which received fees for rating the various pieces.

    . . .

    With the various types of structured-finance deals, a trend began of companies using Special Purpose Entities (SPEs) to hide risks. From an accounting perspective, the key question was whether a company that owned particular financial assets needed to disclose those assets in its financial statements even after it transferred them to an SPE. Just as derivatives dealers had argued that swaps should not be included in their balance sheets, financial companies began arguing that their interest in SPEs did not need to be disclosed . . . In 1991. the acting chief accountant of the SEC, concerned that companies might abuse this accounting standard, wrote a letter saying the outside investment had to be at least three percent (a requirement that helped implode Enron and its auditor Andersen because the three percent investments were phony):

    Jensen Comment
    The "three percent rule" was highly unpopular among investment bankers corporations, and even regulators like the Federal Reserve Bank. Their complaints were largely unheeded, and the FASB eventually raised the ante to ten percent.

    Bob Jensen's reviews of Special Purpose Entities (SPEs), including those at Enron, are at http://www.trinity.edu/rjensen//theory/00overview/speOverview.htm

    Bob Jensen's threads on collateralized debt obligation (CDO) accounting are at http://www.trinity.edu/rjensen/Theory01.htm#CDO

    Some of the many, many lawsuits settled by auditing firms can be found at http://www.trinity.edu/rjensen/Fraud001.htm

    1992

    The International Organization of Securities Commissions (IOSCO) commenced a serious effort to support cross-border accounting standards --- http://www.iosco.org/library/resolutions/pdf/IOSCORES6.pdf
    This is one of the first major steps toward achieving international consistency in accounting for derivative financial instruments and hedging activities.

    1. The members of IOSCO believe it is important to identify ways to facilitate crossborder offerings by multinational issuers. An important factor in encouraging such offerings is the development of a generally accepted body of international standards on auditing which could be used for cross-border offerings and continuous reporting by foreign issuers.

    2. Auditing standards play a critical role in the protection of investors within each country's domestic securities market and are an important part of a country's securities regulatory system. Securities regulatory authorities have responsibility for the development and implementation of that securities regulatory system. Securities regulatory authorities therefore have an important responsibility to ensure that auditing standards are responsive to the need for investor protection.

    3. For several years, the Technical Committee, through its Working Party No. 1 and Sub-Committee on Accounting and Auditing, has worked closely with the International Auditing Practices Committee (the "IAPC") of the International Federation of Accountants ("IFAC") in developing IAPC's international standards on auditing. The Technical Committee has provided commentary, critiques and proposed changes to such auditing standards to ensure that such standards adequately address securities regulators' concerns with investor protection.

    4. After a full review of the IAPC's proposed auditing standards, the Technical Committee believes that the IAPC auditing standards (with the inclusion of the current exposure drafts of three standards that are expected to be finalized by early 1993) set forth on Attachment A represent a comprehensive set of auditing standards and that audits conducted in accordance with these standards could be relied upon by securities regulatory authorities for multinational reporting purposes. It should be noted that the Technical Committee is not making any recommendation with respect to the form of the auditors' report or the IFAC standards relating to auditor qualifications and independence. At present there is not a consensus that the standards in these three areas adequately address the concerns raised by securities regulatory authorities. Working Party No. 1 is continuing to work with the IAPC on these matters. It will also monitor future developments and report periodically to the Technical Committee.

    5. In light of the foregoing and based on the recommendation of the Technical Committee, IT IS HEREBY RESOLVED that the Presidents' Committee recommends that the members of IOSCO:

    a. accept the International Standards on Auditing identified on Attachment A hereto as an acceptable basis for use in cross-border offerings and continuous reporting by foreign issuers; and

     b. take all steps that are necessary and appropriate in their respective home jurisdictions to accept audits conducted in accordance with International Standards on Auditing as an alternative to domestic auditing standards in connection with cross-border offerings and continuous reporting by foreign issuers.

    From Paul Pacter:  IOSCO AGREEMENT (July 1995) --- http://www.trinity.edu/rjensen/acct5341/speakers/pacter.htm#001 

    The [IASC] Board has developed a work plan that the Technical Committee agrees will result, upon successful completion, in IAS comprising a comprehensive core set of standards. Completion of comprehensive core standards that are acceptable to the [IOSCO] Technical Committee will allow the Technical Committee to recommend endorsement of IAS for cross border capital raising and listing purposes in all global markets. IOSCO has already endorsed IAS 7, Cash Flow Statements, and has indicated to the IASC that 14 of the existing International Accounting Standards do not require additional improvement, providing that the other core standards are successfully completed.

    Also see the IOSCO President's Committee year 2000 resolutions --- http://www.iosco.org/library/resolutions/pdf/IOSCORES19.pdf

    Eventually in 2001 IOSCO recommended that its members allow multinational issuers to use 30 IASC standards in cross-border offerings and listing. This action tended to improve the status and acceptance of IASC standards even though it was only a "recommendation" that could easily be overridden by any member nation's law which in most instances required adherence to that nation's standards --- http://en.wikipedia.org/wiki/International_Organization_of_Securities_Commissions
    The IOSCO homepage is at http://www.iosco.org/

    Paul is the Webmaster of
    The IAS Plus International Standards Blog of Deloitte. That blog provides an excellent summary of the history of IAS 39 and all its amendments to date --- http://www.iasplus.com/standard/ias39.htm
     

    Some of the many, many lawsuits settled by auditing firms can be found at http://www.trinity.edu/rjensen/Fraud001.htm

    1993
    Infectious Greed:  How Deceit and Risk Corrupted the Financial Markets  (Henry Holt and Company, 2003, Page 233, ISBN 0-8050-7510-0)

    Europeans had learned about the dangers of derivatives in 1993 when Metallgesellschaft, a German conglomerate, lost $1.4 billion on oil derivatives. The losses at Metalgesellschaft illustrated the difficulty of distinguishing between hedging (reducing risk) and speculating (increasing risk with the hope of higher returns), and also foreshadowed future problems in the energy markets, including the electricity crisis in California and the related collapse of Enron. Unfortunately, few people saw the parallels.

    . . .

     Metallgesellschaft hedged part of this exposure to rising oil prices by buying short-term oil futures on the New Yourk Mercantile Exhagye (NYMEX), the exchange that would figure prominently in Enron's collapse. It also bought over-the-counter oil derivatives in unregulated markets. What about these trades? Were they hedging or speculating.

    In late 1993, oil prices dropped and Metallgesellschaft began losing money on its futures positions. Theoretically, the firm could make up for these losses by selling oil-related products in the future at prices it had locked in on its long-term contracts, which were now higher than prices available in the market. But as the losses on the short-term oil hedges increase, the firm had to pay hundreds of millions of dollars right away, years berfore the future gains from its long-term contracts. On December 17, 1993, directors of the firm's German parent took control of the hedging operation and began selling off the short-term contracts, at huge losses. By January 1994, the firm had lost more than a billion dollars.

     

    Like Metallgesellschaft, the state of Califonia (and its electric utilities) also faced a potential mismatch between the long-term cost of electricity production and short-term revenues from electricity consumers. Because short-term rates were capped by law, California was vulnerable to an increase in electricity prices unless it entered into a long-term contract to purchase electricity. At first, the state of California did not hedge, and it lost billions of dollars when electricity prices increased . . .


    1993
    Frank Partnoy, Page 179 of Chapter 4 entitled "The Mexican Bank Fiesta"
    F.I.A.S.C.O. : The Inside Story of a Wall Street Trader by Frank Partnoy - 283 pages (February 1999) Penguin USA (Paper); ISBN: 0140278796 

    In early 1994 Mexico was hot. The U.S. had recently passed NAFTA --- the North American Free Trade Agreement --- and bankers were racing south to Mexico City . . . What would we feed the Mexian banks? Obviously, it should be high margin adn high volume. We wanted to make as much money as we could. It should be addictive, too, so the banks would gorge themselves. Once the banks were bloated and couldn't eat another bite, it would be easy to bt them down. Then, at the appropriate moment one little nudge could cause the entire obese Mexican banking system to topple like Humpty Dumpty. By 1994 Morgan Stanley was in a position to feed the Mexican banks anything it wanted. During the previous year, the firm had achieved legendary status after it successfully completed its first "PLUS Notes" transaction. "PLUS" was another acronym --- for Peso-linked U.S. Dollar Secured Notes --- and since March 1993 PLUS Notes had been the rage in Mexico. PLUS NOtes were Mexican derivatives denominated and payable in U.S. dollars, and offered both Mexican banks and u.S. buyers an investmetn they never imagined was possible.


    1993
    The International Accounting Standards Committee (later in 2001 changed to the International Accounting Standards Board) , in its revised Exposure Draft E48 on Financial Instruments, proposed extensive disclosure about derivatives and other financial instruments, some of which went beyond disclosures required in the United States at that time. Until the passage of the temporary United States Financial Accounting Standards Board (FASB) derivatives disclosure standard FAS 119 in 1994, derivatives such as forward contracts and swaps did not even have to be disclosed let along booked. As a result companies were rapidly expanding off-balance-sheet financing (OBSF) with derivatives invented in the 1980s, especially interest rate swaps that were rapidly becoming the vehicle of choice for managing cash in banks and other corporations and even not-for-profit organizations.


    1993
    The Group of Thirty a private and independent, nonprofit body that examines financial issues, In its July 1993 study Derivatives: Practices and Principles, the Group of Thirty called for disclosure of information about management's attitude toward financial risks, how derivatives are used and how risks are controlled, accounting policies, management's analysis of positions at the balance sheet date and the credit risk inherent in those positions, and, for dealers, additional information about the extent of activities in derivatives. Derivatives also were the subject of major studies prepared by several federal agencies, all of which cited the need for improvements in financial reporting for derivatives.

    Some of the many, many lawsuits settled by auditing firms can be found at http://www.trinity.edu/rjensen/Fraud001.htm

    1994
    Infectious Greed:  How Deceit and Risk Corrupted the Financial Markets  (Henry Holt and Company, 2003, Page 229, ISBN 0-8050-7510-0)

    Third, financial derivatives were now everywhere --- and largely unregulated. Increasingly, parties were using financial engineering to take advantage of the differences in legal rules among jurisdictions, or to take new risks in new markets. In 1994, The Economist magazine noted, "Some financial innovation is driven by wealthy firms and individuals seeking ways of escaping from the regulatory machinery that governs established financial markets." With such innovation, the regulators' grip on financial markets loosened during the mid-to-late 1990s . . . After Long-Term Capital (Management) collapsed, even Alan Greenspan admitted that financial markets had been close to the brink.


    1994
    Orange County's Billion Dollar Loss:  Watch the a clip of the CBS Sixty Minute module on this enormous scandal ---
    --- http://www.trinity.edu/rjensen/acct5341/Calgary/CDfiles/video/FAS133/SIXTY01.wmv 
    The fraud commenced to unravel in February 1994.

    From Wikipedia --- http://en.wikipedia.org/wiki/Robert_Citron

    Robert Lafee Citron was the longtime Treasurer-Tax Collector of Orange County, California when Orange County declared Chapter 9 bankruptcy on December 6, 1994. Citron was the only Democrat to hold office in otherwise Conservative/Republican Orange County at the time. The bankruptcy was brought on by the county having inadequate capital to allow for any raise in interest rates for its trading positions. A cash crunch occurred when interest rates increased and financiers for the county required increased collateral from the county.

    Citron controlled several Orange County funds including the General Fund, the Investment Pool, and the treasury Commingled Pool. He sent out the county's tax bills with rhyming slogans, such as "Taxes paid on time never draw fines."[1] He won re-election seven times; in his last election victory, his opponent charged that his handsome gains were the result of risky betting.[1]

    As controller of the various Orange County funds, Citron had taken a highly leveraged position using repurchase agreements (repos) and Floating Rate Notes (FRNs). The loss incurred by the usage of these financial instruments reached the amount of $2 billion and was caused by being too highly leveraged for rising federal interest rates.[1] In other words, if federal interest rates had not risen, the massive trading position would have been a substantially profitable position; if interest rates did rise, the trading position would result in substantial losses. In fact, rates rose.

    The Orange County funds, managed by Citron, were worth $20 billion.[1] However, Citron went out to the repo market and leveraged the County Pools to amounts ranging from 158% to over 292%. To obtain this degree of leverage he used Treasury bonds as collateral. Profits of the fund were excessive for a period of time and Citron resorted to concealing the excess earnings. He plead guilty to improperly transferring securities from the Orange County General Fund to the Orange County treasury Commingled Pool.

    The county's finances were not suspect until February of 1994. The Federal Reserve Bank began to raise US interest rates, causing many securities in Orange County's investment pools to fall in value. As a result, dealers were requesting extra margin payments from Orange County. These extra margin payments were funded in part by another bond issue made by Orange County; the size of that bond issue was $600 million. However, this fix proved to be only temporary. In December 1994, Credit Suisse First Boston (CSFB) realized what was going on and blocked the "rolling over" of $1.25 billion in repos ("rollover" essentially means issuing of another repo when the previous one ends, but, at the new prevailing interest rate). At that point Orange County was left with no recourse other than to file for bankruptcy.

    Citron pled guilty to six felony counts and three special enhancements. Charges also included filing a false and misleading financial summary to participants purchasing securities in the Orange County Treasury Investment Pool.

    While in bankruptcy, every county program budget was cut, about 3,000 public employees were discharged and all services were reduced. Citron was ordered to serve five years of supervised probation, and to perform 1000 hours of community service. Citron did not serve any time in prison.

    Some of the many, many lawsuits settled by auditing firms can be found at http://www.trinity.edu/rjensen/Fraud001.htm


    1994
    They were an admixture of old-fashioned and uncouth, a duo almost as unlikely as Neil Simon's odd couple.  The seventy-year-old had been married to the same woman for forty years, in the same job for more than twenty, and in the same place--Orange County, California--forever.  The fifty-four-year-old had recently divorced and remarried, switched jobs often and moved even more frequently, most recently to a million-dollar home in swanky Moraga, east of Oakland, California.  Despite their obvious differences, they spoke on the phone virtually every day for many years.  They first met in 1975 and had traded billions of dollars of securities with each other.  The elder of the pair was the Orange County treasurer, Robert Citron; the younger was a Merrill Lynch bond salesman, Mike Stamenson. 
    Together they created what many officials described as the biggest financial fiasco in the United States: Orange County's $1.7 billion loss on derivatives.

    Frank Partnoy, Page 157 of Chapter 8 entitled "The Odd Couple"
    F.I.A.S.C.O. : The Inside Story of a Wall Street Trader by Frank Partnoy - 283 pages (February 1999) Penguin USA (Paper); ISBN: 0140278796 

    1994
    Additional legal issues ensued for Gibson Greeting Cards in 1994. In October, the company sued its New York banks, Bankers Trust and its affiliate BT Securities Corp., for $73 million over losses resulting from derivatives purchases, then heralded as complex and risky investment vehicles. In November, Gibson and Bankers Trust reached an out-of-court settlement, which ended Gibson's exposure to losses of as much as $27.5 million. According to company officials, Gibson paid Banker's Trust $6.18 million, part of which would come from the $3.4 million Bankers Trust paid to Gibson in earnings on earlier derivative contracts. With the bankruptcy of primary customers, a major earnings misstatement, and the derivative calamity, Gibson also experienced some public relations challenges. Faced with criticism from investors and Wall Street, Gibson began an effort to mend its wounded relations with hostile investors and frustrated industry analysts with a concentrated effort at "opening up." They invited industry analysts to visit their headquarters and made concerted efforts at improving communications at all levels.

    "Gibson Greetings, Inc.," Answers.com --- http://www.answers.com/topic/gibson-greetings-inc?cat=biz-fin


    1994
    On the same day
    (that Gibson Greeting Card announced losses on April 12, 1994), the second derivatives loss was announced. Procter & Gamble Company, the 157 year-old household products maker, said it would take a $102 million charge to close out two losing interest rate swaps, also with Bankers Trust. P&G's loss was the largest derivatives loss ever reported by a U.S. industrial company. Chairman Edwin Artzi admitted, "Derivatives like these are dangerous and we were badly burned."
    Frank Partnoy, Page 93 of Chapter 5 entitled "F.I.A.S.C.O."
    F.I.A.S.C.O. : The Inside Story of a Wall Street Trader by Frank Partnoy
    - 283 pages (February 1999) Penguin USA (Paper); ISBN: 0140278796 


    1994
    Other companies soon after the P&G announcement in 1994 revealed that they were going to take big hits in derivatives, including such companies as Dell, McDonalds, Chrysler, Goodyear, DuPont, Mead, and other. There were also numerous investment funds and pension funds that revealed they were deceived on derivatives contracts sold to them by some of the biggest firms on Wall Street. Hundreds upon hundreds of complicated derivatives contracts were being deceptively (about financial risks) sold around the world by some of the top banks in the world.

    A video clip of the Chairman of the Financial Accounting Standards Board (Denny Beresford) quoting that until 1994 he thought derivatives were "something a person his age took when prunes did not quite do the job."  You can listen to my MP3 recording of Denny's remarks at the American Accounting Association Annual Meetings in August 1993 and 1994 (along with related and free audio and video clips) at http://www.cs.trinity.edu/~rjensen/000overview/mp3/133summ.htm#Introduction 

    Denny Beresford explained that the Chairman of the S.E.C., Arthur Leavitt, declared that the three most important problems for the FASB to address in new accounting standards were "derivatives, derivatives, and derivatives." In 1994 the FASB issued a temporary FAS 119 disclosure standard until FAS 133 was issued in June 1998 and became effective later in year 2000.


    1994
    "Financial derivative instruments and social ethics," by J. Patrick Raines and Charles G. Leathers,  Journal Journal of Business Ethics, 1994.

    Recent finance literature attributes the development of derivative instruments (interest rate futures, stock index futures) to (1) technological advances, and (2) improved mathematical models for predicting option prices. This paper explores the role of social ethics in the acceptance of financial derivatives. The relationship between utilitarian ethical principles and the demise of turn-of-the-century bucket shops is contrasted with modern tolerance of financial derivatives based upon libertarian ethical precepts. Our conclusion is that a change in social ethics also facilitated the growth in trading in modern financial derivatives.

    Some of the many, many lawsuits settled by auditing firms can be found at http://www.trinity.edu/rjensen/Fraud001.htm

    1995
    Infectious Greed:  How Deceit and Risk Corrupted the Financial Markets  (Henry Holt and Company, 2003, Page 235, ISBN 0-8050-7510-0)

    In January 1995, Netherlands Central Bank Governor Wim Duisenberg remarked, "What's needed is that companies that use derivatives tightly control their use and the risks taken. You shouldn't give sophisticated weapons to children."


    1995
    The Queen's Bank, Barings Bank, in the United Kingdom --- http://en.wikipedia.org/wiki/Nicholas_Leeson

    Nicholas Leeson (born February 25, 1967) is a former derivatives trader whose unsupervised speculative trading caused the collapse of Barings Bank, the United Kingdom's oldest investment bank.

    By the end of 1992, the account's losses exceeded £2 million, which ballooned to £208 million by the end of 1994. The beginning of the end occurred on January 16, 1995, when Leeson placed a short straddle in the Stock Exchange of Singapore and Tokyo stock exchanges, essentially betting that the Japanese stock market would not move significantly overnight. However, the Kobe earthquake hit early in the morning on January 17, sending Asian markets, and Leeson's investments, into a tailspin. Leeson attempted to recoup his losses by making a series of increasingly risky new investments, this time betting that the Nikkei Stock Average would make a rapid recovery. But the recovery failed to materialize, and he succeeded only in digging a deeper hole.

    Realising the gravity of the situation, Leeson left a note reading "I'm Sorry" and fled on February 23. Losses eventually reached £827 million (US$1.4 billion), twice the bank's available trading capital. After a failed bailout attempt, Barings was declared insolvent on February 26.

    After fleeing to Malaysia, Thailand and finally Germany, Leeson was arrested and extradited back to Singapore on March 2, 1995, though his wife Lisa was allowed to return to England. While he had authorisation for the January 15 short straddle, he was charged with fraud for deceiving his superiors about the riskiness of his activities and the scale of his losses. Several observers (and Leeson himself) have placed much of the blame on the bank's own deficient internal auditing and risk management practices. Indeed, the Singapore authorities' report on the collapse was scathingly critical of Barings management, claiming that senior officials knew or should have known about the "five eights" account.

    Sentenced to six and a half years in Changi Prison in Singapore, he was released from prison in 1999, having been diagnosed with colon cancer, which he has survived despite grim forecasts at the time.

    While in prison, in 1996, Leeson published an autobiography, Rogue Trader, detailing his acts. A review in the financial columns of the New York Times stated, "This is a dreary book, written by a young man very taken with himself, but it ought to be read by banking managers and auditors everywhere."[1] In 1999, the book was made into a film of the same name starring Ewan McGregor and Anna Friel.


    1995
    A quick review of my outstanding projects with Salant revealed just how bizarre my dealings at Morgan Stanley had become. The (deceptive) transactions I was supposed to be working on included: several AMITs, a half-dozen different Tokyo deals designed to skirt regulations, EDNs, Eagle Pier, additional Pre4 and FP Trust trades, several tax-motivated RAVs, a few Mexican derivatives, and a financing structure fo rthe rehabilitation of some Brazilian F-5 fighter planes. I stared at this list. What in the world had happened to me?

    Frank Partnoy, Page 248 of Chapter 11 entitled "Sayonara."
    F.I.A.S.C.O. : The Inside Story of a Wall Street Trader by Frank Partnoy - 283 pages (February 1999) Penguin USA (Paper); ISBN: 0140278796 


    1995
    These were the roaring 1990s in the rising technology bubble  It was also an era of diminishing protection for investors

    In 1995 Congress joined the Supreme Court in limiting securities lawsuits. The legislative limitations had been in the works since 1991, when Richard C. Breeden, the previous SEC chairman, had testified before Congress that "because baseless securities litigation amounts to a 'tax on capital,' which undermines economic competitiveness, there is a strong public interest in eliminating meritless suits." In 1992, Representative W.j. "Billy" Tauzin, a Democrat from Louisiana, had introduced legislation limiting liability for securities fraud.

    . . .

    When Republicans captured the House of Representatives in November 1994 . . . securities-litigation reform was assured. In a January 1995 speech (SEC Chairman) Levitt outlined the limits on securities regulation that Congress later would support:  limiting, the statute-of -limitations period for filing lawsuits, restricting legal fees paid to lead plaintiffs, requiring plaintiffs to allege more clearly that a defendant acted with reckless intent, and exempting "forward looking statements" --- essentially projections about a company's future --- from legal liability."

    The Private Securities Litigation Reform Act (PSLRA) of 1995 passed easily, and Congress even overrode the veto of President Clinton ...

    Jensen Comment
    PSLRA had the effect of making some frauds highly profitable even if you got caught. This act combined with the way traders and corporate executives got compensation in the 1990s led firms like Enron and a raft of other firms expose their employers to excessive risks and cheat on their accounting reports. At the same time auditing firms were doing as much or more consulting as auditing in companies they audited. For example, the Houston Office of Enron was getting about $25 million per year in consulting fees on top of $25 million in audit fees. This is not conducive to audit independence. At the same time auditors lobbied hard in Congress and got proportional liability relief in PSLRA (replacing  joint and several lawsuit risks). PSLRA greatly limited auditing firms' share of  damages in litigation of failed audit clients. Questions were raised as to whether audit quality eventually took a nosedive leading to such things as the world's worst audit in history (WorldCom) and the fiasco auditing of Enron

    B. Brian Lee, Steve Cox, and Dianne Roden put it this way in the Journal of Forensic Accounting http://www.rtedwards.com/journals/JFA/VIII/271.pdf
    "This apparent loss in the audit quality advantage of big accounting firms is consistent with changes in the audit environment including both increased non-audit services and lowered litigation risk for big accounting firms."

    PSLRA also helped a high flyer trader at Kidder Peabody, Joseph Jett, stay out of jail and save his reputation and fortune. Details are much to complicated but General Electric's 1986 purchase of Kidder turned out to be a succession of disasters, many of them in derivatives trading that cost GE millions upon millions of dollars before Kidder collapsed altogether.

    Infectious Greed:  How Deceit and Risk Corrupted the Financial Markets  (Henry Holt and Company, 2003, Page 183, ISBN 0-8050-7510-0)

    The collapse of Kidder Peabody raised troubling new questions. It seemed virtually impossible to design a system of controls that would catch a rogue trader. Although Jett's remarkable turnaround might have generated suspicion in a different industry, it was very common for traders to find a new product or strategy that produced unusually high returns. How could manager tell if Jett was different from one of John Meriwether's traders at Salomon?

    Even more troubling, the structure of Wall Street compensation seemed to encourage traders to take excessive risks, or even to defraud their firms. In cataloguing many of the instances of "rogue trading," during this period, Professor Jerry W. markham noted that traders were motivated to expose their firms to as much risk as possible to maximize their own compensation.

    Infectious Greed:  How Deceit and Risk Corrupted the Financial Markets  (Henry Holt and Company, 2003, Page 277, ISBN 0-8050-7510-0)

    In reality, bankers and securities analysts had been corrupted by precisely the same forces that had corrupted accountants:  pressure from corporate executives, limitations on liability, and conflicts of interest related to their own firms. Although investors hadn't noticed, there were sighs during the mid-1990s that Wall Street had begun to behave very badly. First were the various derivatives fianscos, with Bankers Trust leading the pack. Then there were a series of scandals in the NASDAQ market, whre most technology stocks were traded . . . In March 1995, several traders from Morgan Stanley allegedly manipulated the markets for several technology stocks --- including Dell Computer, Novell, Sybase, adn Tele-Communications Inc. --- in order to profit from a complex scheme related to NASDAQ options (Morgan Stanley later was fined $1 million and traders involved in the scheme were fined and suspended . . .


    1995
    "The Future of Futures," by Myron Scholes, Risk Management Problems & Solutions, edited by William H. Beaver and George Parker, McGraw-Hill., 1995.
     


    1995

    The International Organization of Securities Commissions (IOSCO) commenced a serious effort to support cross-border accounting standards --- http://www.iosco.org/library/resolutions/pdf/IOSCORES6.pdf
    This is one of the first major steps toward achieving international consistency in accounting for derivative financial instruments and hedging activities.

    1. The members of IOSCO believe it is important to identify ways to facilitate crossborder offerings by multinational issuers. An important factor in encouraging such offerings is the development of a generally accepted body of international standards on auditing which could be used for cross-border offerings and continuous reporting by foreign issuers.

    2. Auditing standards play a critical role in the protection of investors within each country's domestic securities market and are an important part of a country's securities regulatory system. Securities regulatory authorities have responsibility for the development and implementation of that securities regulatory system. Securities regulatory authorities therefore have an important responsibility to ensure that auditing standards are responsive to the need for investor protection.

    3. For several years, the Technical Committee, through its Working Party No. 1 and Sub-Committee on Accounting and Auditing, has worked closely with the International Auditing Practices Committee (the "IAPC") of the International Federation of Accountants ("IFAC") in developing IAPC's international standards on auditing. The Technical Committee has provided commentary, critiques and proposed changes to such auditing standards to ensure that such standards adequately address securities regulators' concerns with investor protection.

    4. After a full review of the IAPC's proposed auditing standards, the Technical Committee believes that the IAPC auditing standards (with the inclusion of the current exposure drafts of three standards that are expected to be finalized by early 1993) set forth on Attachment A represent a comprehensive set of auditing standards and that audits conducted in accordance with these standards could be relied upon by securities regulatory authorities for multinational reporting purposes. It should be noted that the Technical Committee is not making any recommendation with respect to the form of the auditors' report or the IFAC standards relating to auditor qualifications and independence. At present there is not a consensus that the standards in these three areas adequately address the concerns raised by securities regulatory authorities. Working Party No. 1 is continuing to work with the IAPC on these matters. It will also monitor future developments and report periodically to the Technical Committee.

    5. In light of the foregoing and based on the recommendation of the Technical Committee, IT IS HEREBY RESOLVED that the Presidents' Committee recommends that the members of IOSCO:

    a. accept the International Standards on Auditing identified on Attachment A hereto as an acceptable basis for use in cross-border offerings and continuous reporting by foreign issuers; and

     b. take all steps that are necessary and appropriate in their respective home jurisdictions to accept audits conducted in accordance with International Standards on Auditing as an alternative to domestic auditing standards in connection with cross-border offerings and continuous reporting by foreign issuers.

    From Paul Pacter:  IOSCO AGREEMENT (July 1995) --- http://www.trinity.edu/rjensen/acct5341/speakers/pacter.htm#001 

    The [IASC] Board has developed a work plan that the Technical Committee agrees will result, upon successful completion, in IAS comprising a comprehensive core set of standards. Completion of comprehensive core standards that are acceptable to the [IOSCO] Technical Committee will allow the Technical Committee to recommend endorsement of IAS for cross border capital raising and listing purposes in all global markets. IOSCO has already endorsed IAS 7, Cash Flow Statements, and has indicated to the IASC that 14 of the existing International Accounting Standards do not require additional improvement, providing that the other core standards are successfully completed.

    Also see the IOSCO President's Committee year 2000 resolutions --- http://www.iosco.org/library/resolutions/pdf/IOSCORES19.pdf

    Eventually in 2001 IOSCO recommended that its members allow multinational issuers to use 30 IASC standards in cross-border offerings and listing. This action tended to improve the status and acceptance of IASC standards even though it was only a "recommendation" that could easily be overridden by any member nation's law which in most instances required adherence to that nation's standards --- http://en.wikipedia.org/wiki/International_Organization_of_Securities_Commissions
    The IOSCO homepage is at http://www.iosco.org/

    Paul is the Webmaster of
    The IAS Plus International Standards Blog of Deloitte. That blog provides an excellent summary of the history of IAS 39 and all its amendments to date --- http://www.iasplus.com/standard/ias39.htm
     


    1995
    From Paul Pacter:  EUROPEAN COMMN. POLICY (Nov. 1995) --- http://www.trinity.edu/rjensen/acct5341/speakers/pacter.htm#001

    EC statement of policy, Accounting Harmonisation: A New Strategy vis-à-vis International Harmonisation: "Rather than amend existing Directives, the proposal is to improve the present situation by associating the EU with the efforts undertaken by IASC and IOSCO towards a broader international harmonisation of accounting standards.

    Paul is the Webmaster of The IAS Plus International Standards Blog of Deloitte. That blog provides an excellent summary of the history of IAS 39 and all its amendments to date --- http://www.iasplus.com/standard/ias39.htm

    1996
    On June 14, 1996 the United States Financial Accounting Standards Board (FASB) issued the infamous FAS 133 that required most derivative financial instruments (including forward contracts, swaps, futures, and options, and complicated versions thereof) to be booked (initially often at zero historical cost) and than carried at fair value for the life of the contracts.  Implementation requirements scheduled for 1999 were later delayed until 2000.

    Originally the FASB wanted FAS 133 to be quite simple (maybe 50 pages) by requiring that all changes in value of each derivative financial instrument, whether an asset or a liability, be booked with the offset going to current earnings and losses. Banks and corporations objected strenuously to doing this in hedging situations because in many instances the companies would be penalized with wildly fluctuating net earnings in circumstances where they hedged to stabilize earnings.

    Hence the FASB in FAS 133 had to greatly complicate FAS 133 with thousands of pages of new standards, amendments, and implementation guides how to get “hedge accounting” relief for derivatives that are genuinely hedges of cash flows or fair values. Since there are thousands of variations of derivative financial contracts and complicated hedges in practice, both FAS 133 and IAS 39 and their amendments became the most technical and complex standards ever written. FAS 133 amendments include FAS 137 (June 1999), FAS 138 (June 2000), FAS 149 (April 2003), FAS 155 (February 2006), FAS 157(September 2006), FAS 159 (February 2007), and FAS 161 (March 2008). FASB standards can be downloaded at no charge from http://www.fasb.org/st/index.shtml


    1996
    From Paul Pacter: US SEC STATEMENT (April 1996) --- http://www.trinity.edu/rjensen/acct5341/speakers/pacter.htm#001

    The Commission is pleased that the IASC has undertaken a plan to accelerate its development efforts with a view toward completion of the requisite core set of standards by March 1998. The Commission supports the IASC's objective to develop, as expeditiously as possible, accounting standards that could be used for preparing financial statements used in cross-border offerings.
     

    Paul is the Webmaster of The IAS Plus International Standards Blog of Deloitte. That blog provides an excellent summary of the history of IAS 39 and all its amendments to date --- http://www.iasplus.com/standard/ias39.htm


    1996
    While Frank Portnoy was fighting for more financial markets regulation, guess who was fighting against it tooth and nail?
    Few remember that Bill Clinton's administration, along with Greenspan and Levitt, fought successfully against regulation of financial markets.
    It's now Deja vu Larry Summers who is the liberal Keynesian scholar behind President Obama's economic recovery and budget spending.
    People remember Larry Summers as Harvard President who was forced out of office by feminists.
    But few remember that he was also Treasury Secretary during the presidency of Bill Clinton.
    Even fewer remember him as a virulent opponent of financial markets regulation.

    In 1997, Brooksley Born warned in congressional testimony that unregulated trading in derivatives could "threaten our regulated markets or, indeed, our economy without any federal agency knowing about it." Born called for greater transparency--disclosure of trades and reserves as a buffer against losses. Instead of heeding this oracle's warnings, Greenspan, Rubin & Summers rushed to silence her. As the Times story reveals, Born's wise warnings "incited fierce opposition" from Greenspan and Rubin who "concluded that merely discussing new rules threatened the derivatives market." Greenspan deployed condescension and told Born she didn't know what she doing and she'd cause a financial crisis . . . In early 1998, according to the Times story, one of the guys, Larry Summers, called Born to "chastise her for taking steps he said would lead to a financial crisis. But Born kept at it, unwilling to let arrogant men undermine her good judgment. But it got tougher out there. In June 1998, Greenspan, Rubin and the then head of the SEC, Arthur Levitt, Jr., called on Congress "to prevent Ms. Born from acting until more senior regulators developed their own recommendations." (Levitt now says he regrets that decision.) Months later, the huge hedge fund Long Term Capital Management nearly collapsed--confirming some of Born's warnings. (Bets on derivatives were a key reason.) "Despite that event," the Times reports, " Congress (apparently as a result of Greenspan & Summer's urging, influence-peddling and pressure) "froze" Born's Commissions' regulatory authority. The next year, Born left as head of the Commission.Born did not talk to the Times for their article. What emerges is a story of reckless, willful and arrogant action and behaviour designed to undermine a wise woman's good judgment. The three marketeers' disdain for modest regulation of new and risky financial instruments reveals a faith-based fundamentalist approach to the management of markets and risk. If there is any accountability left in our system, Greenspan, Rubin and Summers should not be telling anyone how to run anything. Instead, Barack Obama might do well to bring back Brooksley Born and promote to his team economists who haven't contributed to the ugly mess we're in.
    Katrina vanden Heuvel, "The Woman Greenspan, Rubin & Summers Silenced," The Nation, October 9, 2008 ---
    http://www.thenation.com/blogs/edcut/370925/the_woman_greenspan_rubin_summers_silenced

    Link forwarded by Jagdish Gangolly

    Rubin, Fed chairman Alan Greenspan and Summers were concerned that even a hint of regulation would send all the derivatives trading overseas, costing America business. Summers bluntly insisted that Born drop her proposal, says Greenberger.
    "The Reeducation of Larry Summers:  He's become a champion of massive government intervention in the economy, and he's even learning how to play nice. ," by Michael Hirsh and Evan Thomas, Newsweek Magazine, March 2, 2009 --- http://www.newsweek.com/id/185934

    Larry Summers had the rumpled, slightly sleepy look of a professor who has been up all night solving equations. President Obama's top economic adviser, the man mainly in charge of the immense government bailout, splayed himself on a sofa in the Roosevelt Room in the White House, beneath a portrait of Franklin Roosevelt, and did his best to be patient with two NEWSWEEK reporters. They were asking him to explain how he had changed—reeducated himself—since the freewheeling days of the late 1990s, when Summers had been part of a government that basically got out of the way of the financial markets as they headed for the edge of the cliff.

    Summers responded by quoting John Maynard Keynes, whose economic theory calling for massive government spending became identified with Roosevelt's New Deal and is at the heart of the Obama administration's stimulus plan. "Keynes famously said of someone who accused him of inconsistency: 'When circumstances change, I change my opinion'," said Summers, raising his heavy-lidded eyes at the reporters as he quoted Keynes's kicker: " 'What do you do?' " The implication, not so subtle, is that smart people are not dogmatic—stuck in one narrow ideological groove —but rather open-minded, flexible and intellectually alert—able to change with the times.

    . . .

    Some of the stories go well beyond complaints about his manners. Brooksley Born, chairwoman of the Commodity Futures Trading Commission, received a call in March 1998 in her office in downtown Washington. On the other end was Deputy Treasury Secretary Summers. According to witnesses at the CFTC, Summers proceeded to dress her down, loudly and rudely. "She was ashen," recalls Born's deputy Michael Greenberger, who walked in as the call was ending. "She said, 'That was Larry Summers. He was shouting at me'." A few weeks before, Born had put out a proposal suggesting that U.S. authorities begin exploring how to regulate the vast global market in derivatives. Summers's phone call was the first sign that her humble plan had riled America's reigning economic elite.

    Rubin, Fed chairman Alan Greenspan and Summers were concerned that even a hint of regulation would send all the derivatives trading overseas, costing America business. Summers bluntly insisted that Born drop her proposal, says Greenberger. According to another former CFTC official who would recount the episode only on condition of anonymity, Born was "astonished" Summers would take the position "that you shouldn't even ask questions about a market that was many, many trillions of dollars in notional value—and that none of us knew anything about."

    Arthur Levitt, who was head of the SEC at the time of Born's proposal, today admits flatly that she had things right about derivatives while he, Rubin, Greenspan and Summers didn't. ("All tragedies in life are preceded by warnings," Levitt says. "We had a warning. It was from Brooksley Born. We didn't listen.") Summers told NEWSWEEK: "I believed at the time, and believe much more strongly today, that new regulations with respect to systemic risk were appropriate and necessary, but expressed the strong view of Secretary Rubin, chairman Greenspan and SEC chief Levitt that the way the CFTC was proposing to go about it was likely to be ineffective and itself imposed major risks into the market." (At the time, the Rubin Treasury Department argued against the Born proposal by maintaining that the CFTC didn't have legal jurisdiction.) Still, Summers allowed that "there's no question that with hindsight, stronger regulation would have been appropriate" before the financial crash. He added: "Large swaths of economics are going to have to be rethought on the basis of what's happened." In the past year Summers has refashioned himself as a champion of intensive financial regulation. In his last column for the Financial Times before joining the Obama administration, Summers said the pendulum "should now swing towards an enhanced role for government in saving the market system from its excesses and inadequacies."

    Continued in article
     

     


    1996
    From Paul Pacter: US CAPITAL MARKETS EFFICIENCY ACT (October 1996) Paraphrased --- http://www.trinity.edu/rjensen/acct5341/speakers/pacter.htm#001

     It is the sense of the Congress that:

    • high-quality international accounting standards would greatly facilitate international financing and enhance the ability of foreign corporations to access US markets; and
       
    • the SEC should enhance its vigorous support for the development of high-quality international accounting standards; and
       
    • the SEC should report to Congress on the outlook for successful completion of a set of international standards that would be acceptable to the SEC for offerings by foreign corporations in US markets.

    Paul is the Webmaster of The IAS Plus International Standards Blog of Deloitte. That blog provides an excellent summary of the history of IAS 39 and all its amendments to date --- http://www.iasplus.com/standard/ias39.htm


    1996
    Stanford University Law School Securities Class Action Clearinghouse
    --- http://securities.stanford.edu/
    Index for 1996-? --- http://securities.stanford.edu/companies.html

    Some of the many, many lawsuits settled by auditing firms can be found at http://www.trinity.edu/rjensen/Fraud001.htm

    1997
    The International Accounting Standards Committee (later in 2001 changed to the International Accounting Standards Board) made a decision to commence a comprehensive international accounting standard for disclosure and booking of derivative financial instruments.  ---http://www.trinity.edu/rjensen/acct5341/speakers/pacter.htm#003.03
    Exposure Draft ED62 was subsequently issued on June 17, 1998. The ensuing IAS 39 standard became effective on March 15, 1999 and required calendar year companies to implement the standard in 2001.

    Paul Pacter was in charge of developing both Exposure Draft E62 and the subsequent international standard IAS 39 on accounting for derivative financial instruments (disclosure and booking). You can read Paul's summary of the history of these two documents at http://www.trinity.edu/rjensen/acct5341/speakers/pacter.htm 

    Paul is the Webmaster of The IAS Plus International Standards Blog of Deloitte. That blog provides an excellent summary of the history of IAS 39 and all its amendments to date --- http://www.iasplus.com/standard/ias39.htm


    1997
    Derivative Financial Instruments Market Risk Disclosure Rules Issued by the Securities and Exchange Commission --- http://www.sec.gov/divisions/corpfin/guidance/derivfaq.htm

    On January 28, 1997, the Commission adopted new rules that require disclosures about the policies used to account for derivatives, and certain quantitative and qualitative information about market risk exposures. (See Securities Act Release No. 7386, published in the Federal Register on February 10, 1997.)

    The required disclosures about accounting policies are specified in new Rule 4-08(n) of Regulation S-X and Item 310 of Regulation S-B. The required disclosures about market risk exposures are specified in new Item 305 of Regulation S-K and Item 9A of Form 20-F.

    Frequently asked questions and answers about the new rules are presented on the following pages. The interpretive answers were prepared by the staffs of the Office of the Chief Accountant and the Division of Corporation Finance. Related questions are grouped under appropriate topic headers.

    Contents

    Companies Affected by the New Rules

    When is Compliance Required

    Market Risks Addressed by the Rules

    Accounting Policy Disclosures

    Quantitative Disclosures – General

    Quantitative Disclosures – Interim Reports

    Quantitative Disclosures – Tabular Information

    Quantitative Disclosures – Sensitivity Analysis

    Quantitative Disclosures – Value-At-Risk

    Qualitative Disclosure Requirements

    Safe Harbor Requirements

    If you have additional questions concerning the new rules, please call Cathy Cole, Armando Pimentel or Robert Uhl in the Office of the Chief Accountant at (202) 942-4400. This publication and subsequent revisions and additions, will be posted at the Commissions's internet site: www.sec.gov..

    Companies Affected by the New Rules

    Question

    1.Which companies must comply with the new rules? Do the rules apply to small business issuers? Investment companies? Foreign companies?

    Answer

    The accounting policy disclosures must be furnished by all companies that must comply with Regulations S-X or S-B. Registered investment companies, small business issuers, and foreign private issuers filing under Item 18 of Form 20-F must comply. The rule does not apply to foreign private issuers filing under Item 17 of Form 20-F. Those issuers should consider Staff Accounting Bulletin Topic 1:D to determine if information regarding accounting policies for derivatives is necessary in MD&A.

    The quantitative and qualitative disclosures of market risk must be furnished by companies that must provide MD&A, except small business issuers. These requirements also do not apply to registered investment companies, who are not required to comply with Regulation S-K, but do apply to foreign private issuers that must comply with Item 9A of Form 20-F.

    When Compliance is Required

    Question

    2.When must companies begin furnishing the accounting policy disclosures required by the new rules?

    Answer

    All companies must furnish the derivative accounting policy disclosures specified by the rule in filings that include financial statements for either an annual or interim fiscal period ending after June 15, 1997. If the accounting policy disclosures are not included in the company's most recently filed Form 10-K, the disclosures are required in the company's interim financial statements filed on Form 10-Q.

    Question

    3.When must companies begin furnishing the quantitative and qualitative disclosures of market risk?

    Answer

    All companies with market capitalizations of more than $2.5 billion on January 28, 1997, and all banks and thrifts of any size market capitalization, must provide the quantitative and qualitative information in filings that include audited financial statements for fiscal years ended after June 15, 1997. For all other companies except small business issuers, the disclosures are required in filings that include audited financial statements for fiscal years ended after June 15, 1998.

    Question

    4. How is market capitalization defined?

    Answer

    Market capitalization is the aggregate market value of common equity calculated for Form S-3 eligibility (General Instruction I.B.1 of that form), with two exceptions. First, market capitalization includes common equity held by both affiliates and nonaffiliates. Second, the determination is made as of January 28, 1997, rather than the 60 day period before the filing.

    Question

    5.Must a nonbank or nonthrift company that has no public common equity outstanding at January 28, 1997, such as a first time company or a company with only public debt securities outstanding, comply with the new rule before it files audited financial statements for a fiscal year ending after June 15, 1998?

    Answer

    No.

    Question

    6.Must a foreign private issuer with common equity held by public shareholders outside the U.S. comply with the new rule before it files audited financial statements for a fiscal year ending after June 15, 1998, if it has no common equity listed in the U.S. at January 28, 1997?

    Answer

    Yes. Disclosures are required if its aggregate market capitalization exceeds $2.5 billion at January 28, 1997.

    Question

    7.When do Item 305 or Item 9A disclosures apply to a foreign bank not regulated in the U.S.? A nonbank U.S. company that has a bank subsidiary?

    Answer

    The rules define a bank or thrift as any company that has control over a depository institution. A depository institution is further defined as:

    (a) a depository institution as defined by the Federal Deposit Insurance Act, or

    (b) an institution organized under the laws of the United States, any state in the U.S., the District of Columbia, and any U.S. territory, which accepts demand deposits or deposits that the depositor may withdraw by check or similar means.

    If a foreign private issuer with banking operations has a market capitalization of less than $2.5 billion at January 28, 1997, and none of its banks meet the definition of a depository institution in the rule, the market risk disclosures specified by Item 9A of Form 20-F are not required until it includes audited financial statements for fiscal years ended after June 15, 1998. Many foreign banks must furnish the disclosure because they own at least one banking subsidiary organized under U.S. laws.

    Question

    8.Must a company primarily engaged in nonbanking businesses furnish the disclosures in filings that include audited financial statements for fiscal years ended after June 15, 1997 because it has a single bank subsidiary that conducts credit card activities?

    Answer

    Yes. If one of its subsidiaries meets the definition of a depository institution, then the company is subject to the disclosure requirements when its filing includes audited financial statements for a fiscal year ended after June 15, 1997, regardless of its market capitalization at January 28, 1997.

    Question

    9.The Commission release contains interpretive guidance. When is that guidance effective?

    Answer

    The Commission's release reminds companies of the requirements of Rule 12b-20 under the Exchange Act and Rule 408 under the Securities Act. Specifically, the release observes that companies provide information about specific terms, fair values, and cash requirements of assets, liabilities, and anticipated transactions. If derivatives are used to alter the characteristics of these items, disclosure of how derivatives, either directly or indirectly, affect terms, fair values, or cash flows of those items is necessary to keep the disclosures about the hedged item from being misleading.

    That interpretive guidance was contained in the proposing release issued in December 1995. It applied to all companies immediately upon its publication in the Federal Register.

    Market Risks addressed by the Rules

    Question

    10.What types of market risk exposures are addressed by the new disclosure rules?

    Answer

    The rules address risks arising from changes in interest rates, foreign currency exchange rates, commodity prices, equity prices, and other market changes that affect market risk sensitive instruments.

    Question

    11.What types of assets, liabilities and transactions must be considered for the market risk disclosures? Do the rules address liabilities from issuing insurance contracts or investments accounted for using the equity method?

    Answer

    The rules require disclosure about market risk exposures arising from derivative financial instruments, as well as all other financial instruments, and derivative commodity instruments. The term "derivative financial instruments" is defined by generally accepted accounting principles (GAAP). (See, for example, FASB Statement 119.) It includes futures, forwards, swaps, options, and other financial instruments with similar characteristics.

    "Other financial instruments" also is defined by GAAP. It excludes instruments such as insurance contracts, warranty contracts, equity method investments, and other items that have been excluded from fair value disclosure standards. (See FASB Statement 107,paragraph 8). It also excludes trade accounts receivable and payable if their carrying value approximates fair value.

    "Derivative commodity instruments" is defined in the release to include commodity futures, forwards, swaps, options, and other commodity instruments with similar characteristics that are permitted by contract or business custom to be settled in cash or with another financial instrument.

    Question

    12.A company can have market risk exposure because of a nonfinancial asset, liability or transaction, such as its inventory or sales commitments. Those risks may or may not be hedged using derivative financial instruments. Must the market risk exposure of the nonfinancial position be included in the disclosures responsive to the new rule?

    Answer

    No. Companies are encouraged but not required to include other market risk sensitive transactions or positions. If a company elects to include a particular type of instrument, position, or transaction in the quantitative disclosures, the registrant must include all of the transactions and positions that create market risk in that risk exposure category.

    Example 1

    If a company's policy is to hedge 60% of the next period's German sales, then voluntary disclosures about the sales transactions must include 100% of the next period's German sales. Including only 60% of the next period’s sales will not comply with the rules.

    Example 2

    Assume an agricultural producer has a policy of hedging 100% of next period's wheat deliveries in Chicago but none of its wheat deliveries in Toledo. Voluntary information about earnings or cash flow risks must include 100% of next period's wheat deliveries in both cities. Next, assume the policy was to hedge wheat being delivered to Chicago but not hedge pork belly deliveries to Toledo. The market risk exposures of the two commodities are sufficiently different that only the Chicago wheat deliveries are required in the voluntary disclosures of market risk sensitive positions.

    Continued at http://www.sec.gov/divisions/corpfin/guidance/derivfaq.htm

    Accounting Policy Disclosures

    Quantitative Disclosures – General

    Quantitative Disclosures – Interim Reports

    Quantitative Disclosures – Tabular Information

    Quantitative Disclosures – Sensitivity Analysis

    Quantitative Disclosures – Value-At-Risk (VaR)

    Qualitative Disclosure Requirements

    Safe Harbor Requirements

    Also see http://www.sec.gov/divisions/corpfin/acctdisc_old.htm

    These are in addition to the derivatives disclosure rules of FAS 119 and later FAS 133 ---


    1997
    Infectious Greed:  How Deceit and Risk Corrupted the Financial Markets
      (Henry Holt and Company, 2003, Page 384, ISBN 0-8050-7510-0)

    By comparison, Long-Term Capital Management had $1.25 trillion of derivatives, less than five percent of JP Morgan's yet the Federal Reserve was fored to engineer a bank-led bailout in 1998 because of concerns about such systemic risks. Banking regulators obviously didn't want to do this again. Greenspan's implicit message was that derivatives dealers should be extra careful not to become too exposed to any one of their competitors. He especially seemed to direct this message to anyone dealing with JP Morgan.

    Second, Greenspan warned that dealers needed to disclose more information about their derivatives. Financial institutions have lengthy footnotes chock-full of tables setting forth various financial data, including details about derivatives. But their hundred-plus annual reports are opaque, even to research analysts covering the industry. Here, Greenspan's language was unusually pointed:  "Transparency challenges market participants to present information in ways that accurately reflect risks. Much disclosure currently falls short of these more demanding goals."

    In this case, JP Morgan's disclosures actually were better than those of its peers. The bank reported various risk measures, including "Value-At-Risk," which captured in a single number the firm's highest expected loss under certain assumptions. The bank also said it analyzed worst-case scenarios using a more sophisticated system called "Risk Identification for Large Exposures," better known by the not-so-reassuring acronym "RIFLE." Unfortunately, shareholders didn't get a lot of information about RIFLE.

    Similarly, the bank reported that 94 percent of its derivatives assets and liabilities were valued based on "internal models with significant observable market parameters." Investors should be nervous about the use of internal models to value derivatives --- recall that when Askin Capital Management discovered its internal models were in error its fun collapsed instantaneously. It would be better if banks used only quoted market prices, but those aren't available in many derivatives markets, and will be less available if markets become less liquid. Moreover, "internal models with significant observable parameters" are better than "internal models with unobservable market parameters." Unfortunately, JP Morgan (like many derivatives dealers) also reported many of those not-so-comforting "unobservable" valuations.

    Jensen Comment
    Many of these valuation problems were dealt with when the Financial Accounting Standards Board issued FAS 157 in September 2006 ---
    http://www.trinity.edu/rjensen/Theory01.htm#FairValue


    1997
    Stanford University Law School Securities Class Action Clearinghouse
    --- http://securities.stanford.edu/
    Index for 1996-? --- http://securities.stanford.edu/companies.html 

    Some of the many, many lawsuits settled by auditing firms can be found at http://www.trinity.edu/rjensen/Fraud001.htm

    1998
    The classic and enormous scandal was Long Term Capital Management led by Nobel Prize winning Robert Merton and Myron Scholes (actually the blame is shared  with their devoted doctoral students).  There is a tremendous (one of the best videos I've ever seen on the Black-Scholes Model) PBS Nova video ("Trillion Dollar Bet") explaining why LTC collapsed.  Go to http://www.pbs.org/wgbh/nova/stockmarket/ 
    The "Trillion Dollar Bet" transcripts are free --- http://www.pbs.org/wgbh/nova/transcripts/2704stockmarket.html
    However, you really have to watch the graphics in the video to appreciate this educational video --- http://www.pbs.org/wgbh/nova/stockmarket/
    Also see http://www.trinity.edu/rjensen/FraudCongress.htm#LTCM
    From Wikipedia on November 9, 2004 --- http://en.wikipedia.org/wiki/Long-Term_Capital_Management 

    Long-Term Capital Management was a hedge fund company founded by John Meriwether (a former bond trader at Salomon Brothers bank) in 1994 and with Nobel Prize winners Myron Scholes and Robert Merton on the board. Also joining him as principals were Eric Rosenfeld, Greg Hawkins, Larry Hilibrand, Dick Leahy, Victor Haghani and James McEntee. On 24 February, with $1,011,060,243 of investor capital, LTCM began trading

     . . .

    The fund also invested in other derivative security products such as equity options and mortgage securitisations.

    The downfall of the fund started in May and June 1998 when net returns fell to -6.42 and -10.14 per cent reducing LTCM's capital by $461 million. This was further aggravated by the exit of Salomon Brothers from the arbitrage business in July 1998.

    The scheme finally unraveled in August and September 1998 when the Russians defaulted on their sovereign debt (GKOs). Panicked investors sold Japanese and European bonds to buy U.S. treasury bonds. The profits that were supposed to occur as the value of these bonds converged became huge losses as the value of the bonds diverged. By the end of August the fund had lost $1.85 billion in capital.

    The company was providing returns of almost 40% up to this point, and a "flight to liquidity" the company lost a possible $100 bn and needed an Federal Reserve Bank of New York organised bail-out of $3.625 bn, apparently in order to avoid a wider collapse in the financial markets. The fear was that there would be a chain reaction, as one company liquidated its securities to cover its debt leading to a drop in prices which would force other companies to liquidate its debt creating a vicious cycle. The total losses were found to be $4.6 billion.

    For more details see http://www.trinity.edu/rjensen/FraudCongress.htm#LTCM


    1998
    Infectious Greed:  How Deceit and Risk Corrupted the Financial Markets
      (Henry Holt and Company, 2003, Page 384, ISBN 0-8050-7510-0)

    By comparison, Long-Term Capital Management had $1.25 trillion of derivatives, less than five percent of JP Morgan's yet the Federal Reserve was fored to engineer a bank-led bailout in 1998 because of concerns about such systemic risks. Banking regulators obviously didn't want to do this again. Greenspan's implicit message was that derivatives dealers should be extra careful not to become too exposed to any one of their competitors. He especially seemed to direct this message to anyone dealing with JP Morgan.

    Second, Greenspan warned that dealers needed to disclose more information about their derivatives. Financial institutions have lengthy footnotes chock-full of tables setting forth various financial data, including details about derivatives. But their hundred-plus annual reports are opaque, even to research analysts covering the industry. Here, Greenspan's language was unusually pointed:  "Transparency challenges market participants to present information in ways that accurately reflect risks. Much disclosure currently falls short of these more demanding goals."

     

    1998
    In 1998, Cendant Corporation was accused of fraud after their company's merging of CUC International and HFS Incorporated in 1997. Cendant inflated the company's revenue by $500 million over a period of three years. At the time, this fiasco was the largest case of accounting fraud in the country's history. Former Cendant Corp. vice chairman E. Kirk Shelton was sentenced Wednesday to 10 years in prison and ordered to pay $3.27 billion restitution for his role in an accounting scandal. ---
    http://www.washingtonpost.com/wp-dyn/content/article/2005/08/03/AR2005080302177.html

    Infectious Greed:  How Deceit and Risk Corrupted the Financial Markets  (Henry Holt and Company, 2003, Page 218, ISBN 0-8050-7510-0)

    There were some signs, even in the early accounting scandals, of new financial instruments lurking in the background. To give one example, one of Cendant's first acts after the merger of CUC and HFS was to issue $1 billion of new financial instruments bizarrely called FELINE PRIDES. A few months later, owners of these FELINE PRIDES would become embroild in litigation surrounding Cendant, as yet another victim of the company's fraud.


    1998
    The International Accounting Standards Committee (later in 2001 changed to the International Accounting Standards Board) issued
    Exposure Draft ED62 was subsequently issued on June 17, 1998. The ensuing IAS 39 standard became effective on March 15, 1999 and required calendar year companies to implement the standard by 2001.

    Paul Pacter was in charge of developing both Exposure Draft E62 and the subsequent international standard IAS 39 on accounting for derivative financial instruments (disclosure and booking). You can read Paul's summary of the history of these two documents at http://www.trinity.edu/rjensen/acct5341/speakers/pacter.htm 

    Paul is the Webmaster of The IAS Plus International Standards Blog of Deloitte. That blog provides an excellent summary of the history of IAS 39 and all its amendments to date --- http://www.iasplus.com/standard/ias39.htm


    1998
    Infectious Greed:  How Deceit and Risk Corrupted the Financial Markets  (Henry Holt and Company, 2003, Page 375, ISBN 0-8050-7510-0)

    Banks sued credit default swaps to transfer credit risk, the risk that they would not be repaid money they had loaned to other companies. The bought credit protection from investors by agreeing to pay a fee in exchange for the right to receive payment if a particular company defaulted on its debts. Credit default swaps were ideal for commercial banks, because they enabled them to cut their risks while reluctant the regulatory charges they had to pay for loans they already had made. When the Federal Reserve issued guidelines in June 1997 making these regulatory benefits clear, and the Asia crisis followed immediately thereafter, banks such as J.P. Morgan and Citigroup rushed to do credit default swaps, to lower their risks and regulatory costs.

    The market for credit default swaps was tested in 1998, why Russia announced a "rescheduling" of its local debt market, and parties disputed whether that announcement was a "default" according to the ambiguous language in some credit default swaps. But the swap dealers tightened the language in response, and the market doubled and then doubled again. By 2002, the banks had done hundreds of billions of dollars of credit default swaps based on various borrowers throughout the world. This was why the banks were reasonably safe, even though they had loaned hundreds of billions of dollars to those companies.

    Infectious Greed:  How Deceit and Risk Corrupted the Financial Markets  (Henry Holt and Company, 2003, Page 381, ISBN 0-8050-7510-0)

    Thus, credit default swaps distorted global investment by leading parties to misprice credit risk. Borrowers who were not being monitored intended to take on greater risks, which meant that the banks making new loans to these borrowers would charge higher interest rates. As the cost of capital in the economy increased, companies would take on fewer projects at high cost, and economic growth would suffer. The International Monetary Fund concluded, "To the extent that regulatory arbitrage drives the growth of the market, banks may be encouraged to originate more credit business than they would have done otherwise and then transfer the risk to non- - or less-well-regulated entities . . . such as insurance companies and, to a lesser degree, hedge funds.


    1998
    The Woman Who Tried Early On to Save Our Money and Prevent This Economic Crisis and Countless Financial Frauds
    Brooksley Born --- http://en.wikipedia.org/wiki/Brooksley_Born
    In 1964, Brooksley was the first female student in history to become President of Stanford's Law Review.

    The Obama administration has pledged an overhaul of the financial system, including the way derivatives are regulated. Worrisome to some observers is the fact that his economic team includes some former Treasury officials who were lined up in opposition to Born a decade ago.
    "Prophet and Loss," by Rick Schmitt, Stanford Magazine, March/April 2009, pp. 40-47.

    Brooksley Born (the first woman at Stanford to be president of the Law Review) was named to head the Commodity Futures Trading Commission in 1996. She “advocated reigning in the huge and growing market for financial derivatives…Back in the 1990’s, however, Born’s proposal stirred an almost visceral response from other regulators in the Clinton administration (notably explosive and rude 1998 reactions from Treasury Secretary Robert Rubin and Deputy Secretary Larry Summers and SEC Chairman Arthur Levitt to her suggestion that derivatives swap markets be regulated)  as well as members of Congress and lobbyists…Ultimately Greenspan and the other regulators foiled Born’s efforts and Congress took the extraordinary step of enacting legislation that prohibited her agency from taking any action…Speaking out for the first time, Born says she takes no pleasure from the turn of events. She says she was just doing her job based on the evidence in front of her. Looking back, she laments what she says was the outsized influence of Wall Stret lobbyists on the process, and the refusal of her fellow regulators, especially Greenspan, to discuss even modest reforms. ‘Recognizing the dangers…was not rocket science, but it was contrary to the conventional wisdom and certainly contrary to the economic interests of Wall Street at the moment,‘ she says.”
    As quoted on March 20, 2009 at http://openpalm.wordpress.com/2009/03/20/the-woman-who-tried-to-save-our-money/


    Stanford University Law School Securities Class Action Clearinghouse --- http://securities.stanford.edu/
    Index for 1996-? --- http://securities.stanford.edu/companies.html

    Some of the many, many lawsuits settled by auditing firms can be found at http://www.trinity.edu/rjensen/Fraud001.htm

    1999
    The decade was peppered with financial debacles, but these faded quickly from memory even as they increased in size and complexity. The billion dollar-plus scandals included some colorful characters (Robert Citron of Orange County, Nick Leeson of Barings, and John Meriwether of Long-Term Capital Management), but even as each new scandal outdid the others in previously unimaginable ways, the markets merely hic-coughed and then started going up again. It didn't seem that anything serious was wrong, and their ability to shake off a scandal made markets seem even more under control.
    Frank Portnoy, Infectious Greed (Henry Holt and Company, 2003, Page 2, ISBN 0-8050-7510-0).

    1999
    In June 1999 the United States Financial Accounting Standards Board (FASB) issued the FAS 137 amendments to FAS 133. This is a brief amendment dealing mostly with implementation issues and dates.

    The International Accounting Standards Committee (later in 2001 changed to the International Accounting Standards Board) issued IAS 39, its most complicated standard ever, on March 15, 1999 that forced companies subject to IASC standards to implement IAS 39 beginning in 2001.

    The International Accounting Standards Board issued its most complicated standard ever, IAS 39, in 1999 and required firms to start implementing its rules for accounting for derivative financial instruments and financial hedging --- http://www.iasb.org/Home.htm

    IAS 39 followed FAS 133 nearly three years in timing and borrowed heavily from FAS 133. However, IAS 39 is less technical in terms of many details and does not have the accompanying Derivative Implementation Group (DIG) and other FAS 133 implementation guidelines and rulings. Also there are many important and less-important differences between IAS 39 and FAS 133. Although there are differences between the international IAS 39 and the U.S. FAS 133, they are equivalent in spirit. You can read more about differences between the two standards at http://www.trinity.edu/rjensen/caseans/canada.htm

    Paul Pacter was in charge of developing both Exposure Draft E62 and the subsequent international standard IAS 39 on accounting for derivative financial instruments (disclosure and booking). You can read Paul's summary of the history of these two documents at http://www.trinity.edu/rjensen/acct5341/speakers/pacter.htm  IAS 39 has had substantial revisions since Pau made this presentation at the annual meetings of the American Accounting Association on August 16, 1998.

    Paul is the Webmaster of The IAS Plus International Standards Blog of Deloitte. That blog provides an excellent summary of the history of IAS 39 and all its amendments to date --- http://www.iasplus.com/standard/ias39.htm


    1999
    Stanford University Law School Securities Class Action Clearinghouse
    --- http://securities.stanford.edu/
    Index for 1996-? --- http://securities.stanford.edu/companies.html

    Some of the many, many lawsuits settled by auditing firms can be found at http://www.trinity.edu/rjensen/Fraud001.htm


    1999
    The Gramm-Leach-Bliley Act, also known as the Gramm-Leach-Bliley Financial Services Modernization Act, Pub. L. No. 106-102, 113 Stat. 1338 (November 12, 1999), is an Act of the United States Congress which repealed the Glass-Steagall Act, opening up competition among banks, securities companies and insurance companies. The Glass-Steagall Act prohibited a bank from offering investment, commercial banking, and insurance services. --- http://en.wikipedia.org/wiki/Gramm-Leach-Bliley_Act

     

    2000
    The Year 2000 controversial law referred to in the video is the Commodity Futures Modernization Act of 2000 --- http://en.wikipedia.org/wiki/Commodities_Futures_Modernization_Act
    Also see http://knowledge.wpcarey.asu.edu/article.cfm?articleid=1682

    This legislation was conducive to the credit derivative scandals of Year 2008 --- http://www.trinity.edu/rjensen/2008Bailout.htm


    2000
    The Infamous Footnote 16 from the Year 2000 Enron Annual Report  
    http://www.enron.com/corp/investors/annuals/2000/ar2000.pdf

    Also see http://www.trinity.edu/rjensen/FraudEnron.htm#Senator


    2000
    In June 2000 the United States Financial Accounting Standards Board (FASB) issued the FAS 138 amendments to FAS 133. This is a long and highly technical amendment that expanded hedge accounting into some areas not allowed in the original FAS 133 such as interest rate benchmarking (thereby redefining interest rate risk) and cross-currency hedging. Other changes were introduced in FAS 133:

    • ·Amendment Related to Normal Purchases and Normal Sales
    • Amendments to Redefine Interest Rate Risk
    • Amendments Related to Hedging Recognized Foreign-Currency-Denominated Assets and Liabilities
    • ·Amendments Related to Intercompany Derivatives
    • Amendments for Certain Interpretations of Statement 133 Cleared by the Board Relating to the Derivatives Implementation Group Process
    • Amendments to Implement Guidance in Implementation Issue No. G3, “Discontinuation of a Cash Flow Hedge”
    • Amendments to Implement Guidance in Implementation Issue No. H1, “Hedging at the Operating Unit Level” 
    • Amendments to Implement Guidance in Implementation Issue No. H2, “Requirement That the Unit with the Exposure Must Be a Party to the Hedge”
    • Amendments to the Transition Guidance, the Implementation Guidance in Appendix A of Statement 133, and the Examples in Appendix B of Statement

    You can listen to the (mostly negative) audio clip reactions of executives from accounting firms, banks, investment banks, large corporations, and credit rating agencies at http://www.cs.trinity.edu/~rjensen/000overview/mp3/133summ.htm

    Bob Jensen's free multimedia tutorials and videos on accounting for FAS 133 and IAS 39 are linked at http://www.trinity.edu/rjensen/caseans/000index.htm

    An extensive glossary on accounting for derivative financial instruments --- http://www.trinity.edu/rjensen/acct5341/speakers/133glosf.htm


    2000
    Commodity Futures Modernization Act of 2000 --- http://en.wikipedia.org/wiki/Commodity_Futures_Modernization_Act_of_2000

    The Commodity Futures Modernization Act of 2000 or CFMA (Public Law 106–554, §1(a)(5) [H.R. 5660], December 21, 2000, 114 Stat. 2763, 2763A–365, 7 U.S.C. § 1), was passed by the United States Congress and signed by President Bill Clinton in December 2000 in large part to allow for the creation of U.S. exchanges for the listing of a new sort of derivative security, the single-stock future.

    The Enron Loophole

    The CFMA has received criticism for the so-called "Enron Loophole," 7 U.S.C. §2(h)(3) and (g), which exempts most over-the-counter energy trades and trading on electronic energy commodity markets. The "loophole" was drafted by Enron Lobbyists seeking a deregulated atmosphere for their new experiment, "Enron On-line"[

    The prohibition on single-stock futures and narrow-based indices that had been in effect until the passage of this act was known as the Shad-Johnson Accord because it was first announced in 1982, as part of a jurisdictional pact between John S.R. Shad, then chairman of the U.S. Securities and Exchange Commission and Phil Johnson, then chairman of the Commodity Futures Trading Commission.


    2000
    The International Organization of Securities Commissions (IOSCO) recommends that its members allow multinational issuers to use 30 IASC standards in cross-border offerings and listing. This action tended to improve the status and acceptance of IASC standards even though it was only a "recommendation" that could easily be overridden by any member nation's law which in most instances required adherence to that nation's standards --- http://en.wikipedia.org/wiki/International_Organization_of_Securities_Commissions
    The IOSCO homepage is at http://www.iosco.org/

    European Commission (EC) announces plans to require IASC standards for all EU listed companies from no later than 2005.
    You can read more about the European Commission at http://en.wikipedia.org/wiki/European_Commission

    The IOSCO and EC actions helped the upgrading of the IASC to the International Accounting Standards Board (IASB) later in 2001 --- http://en.wikipedia.org/wiki/International_Accounting_Standards_Board
    The IASB homepage is at http://www.iasb.org/Home.htm


    2000
    Stanford University Law School Securities Class Action Clearinghouse
    --- http://securities.stanford.edu/
    Index for 1996-? --- http://securities.stanford.edu/companies.html

    Some of the many, many lawsuits settled by auditing firms can be found at http://www.trinity.edu/rjensen/Fraud001.htm

    U.S. Companies must now, since Year 2000, implement FAS 133 on "Accounting for Derivative Financial Instruments and Hedging Activities." The most important feature is that now most derivatives, whether or not they are hedging instruments, must be carried at fair value, including forward contracts and swaps that were not even required to be disclosed in the earlier years --- http://www.trinity.edu/rjensen/caseans/000index.htm

    2001
    Enron Declared Bankruptcy in 2001
    History of the Rise and Fall of Enron --- http://www.trinity.edu/rjensen/FraudEnron.htm
    Bob Jensen's Enron Quiz --- http://www.trinity.edu/rjensen/FraudEnronQuiz.htm
    And don't forget about the Enron home video starring some of the real players (including Jeff Skilling) before they got caught --- http://www.trinity.edu/rjensen/FraudEnron.htm#HFV

    Was Enron really a loser or did outside forces bring it down?

    A person can be a professional thief only if he is recognized and received as such by other professional thieves. Professional theft is a group way of life.
    Edwin Sutherland

    There will always be white collar crime as long as it pays big even when you get caught.
    Bob Jensen --- http://www.trinity.edu/rjensen/FraudConclusion.htm#CrimePays

    Enron's Timeline From Beginning to End --- http://www.trinity.edu/rjensen/FraudEnron.htm#EnronTimeline

    Memorable quotations about Enron, Worldcom, and Andersen --- http://www.trinity.edu/rjensen/FraudEnron.htm#Quotations

    Special Report on the Fall of Enron  --- http://www.chron.com/news/specials/enron/

    Frontline (from PBS) videos on accounting and finance regulation and scandals in the U.S. --- http://www.pbs.org/wgbh/pages/frontline/shows/regulation/view/ Note that one of the Frontline videos in about the Enron scandal --- http://www.pbs.org/wgbh/pages/frontline/shows/regulation/view/

    From Wikipedia --- http://en.wikipedia.org/wiki/Enron

    Enron Creditors Recovery Corporation (formerly Enron Corporation) (former NYSE ticker symbol: ENE) was an American energy company based in Houston, Texas. Before its bankruptcy in late 2001, Enron employed around 22,000 people (McLean & Elkind, 2003) and was one of the world's leading electricity, natural gas, pulp and paper, and communications companies, with claimed revenues of $111 billion in 2000. Fortune named Enron "America's Most Innovative Company" for six consecutive years. At the end of 2001 it was revealed that its reported financial condition was sustained mostly by institutionalized, systematic, and creatively planned accounting fraud (see: Enron scandal). Enron has since become a popular symbol of willful corporate fraud and corruption.

    Enron filed for bankruptcy protection in the Southern District of New York in late 2001 and selected Weil, Gotshal & Manges as their bankruptcy counsel. Enron still exists as an asset-less shell corporation, emerging from bankruptcy in November of 2004 after one of the biggest and most complex bankruptcy cases in U.S. history. On September 7, 2006, Enron sold Prisma Energy International Inc., its last remaining business, to Ashmore Energy International Ltd. Following the scandal, lawsuits against Enron's directors were notable because the directors settled the suits by paying very significant sums of money personally. The scandal also caused the dissolution of the Arthur Andersen accounting firm, affecting the wider business world.

    Infectious Greed:  How Deceit and Risk Corrupted the Financial Markets  (Henry Holt and Company, 2003, Page 297, ISBN 0-8050-7510-0)

    A close analysis of the dealings at Enron leads to three key conclusions, each counter to the prevailing wisdom about the company. First, Enron was, in reality, a derivatives-trading firm, not an energy firm, and it took much more risk than anyone realized. By the end, Enron was even more volatile than a highly leveraged Wall Street investment bank, although few investors realized it.

    Second, Enron's core business of derivatives trading was actually highly profitable, so profitable, in fact, that Enron almost certainly would have survived if key parties had understood the details of its business. Instead, in late 2001, Enron was hoist with its own petard, collapsing --- not because it wasn't making money --- but because institutional investors and credit-rating agencies abandoned the company when they learned that Enron's executives had been using derivatives to hide the risky nature of their business.

    Jensen Comment
    Be that as it may, Enron's derivatives traders were performing illegal and unethical market manipulations while Enron dominated the newly unregulated energy trading market.

    The Infamous Footnote 16 from the Year 2000 Enron Annual Report  
    http://www.enron.com/corp/investors/annuals/2000/ar2000.pdf

    Also see http://www.trinity.edu/rjensen/FraudEnron.htm#Senator

    "The Case Against Ken Lay Enron's former chief claims he was out of the loop. How prosecutors aim to show otherwise" by Julie Rawe, Time Magazine, July 19, 2004 --- http://www.time.com/time/magazine/article/0,9171,1101040719-662791,00.html 

    Oct. 23, 2001, stands out as a particularly bad day for Ken Lay. As word circulated that the energy giant he founded was under investigation for balance-sheet shenanigans, the CEO tried to pull Enron's stock out of a tailspin by arranging a special conference call with analysts. "We're not trying to conceal anything," he told them. "I'm disclosing everything we've found." After Lay got off the phone, he gathered Enron's thousands of employees via a live webcast and video teleconference, and tried to reassure them too. "Our liquidity is fine," he said of the company that was about to flame out in one of the biggest accounting scandals in history. "As a matter of fact, it's better than fine. It's strong."

    Those comments came back to haunt Lay last week in an 11-count indictment accusing him of conspiring to cook Enron's books even as he touted its tainted stock. For starters, prosecutors claim that Lay failed to mention to analysts several massive problems he knew about, including some $7 billion in hidden debts. And he neglected to tell employees that the company's liquidity hinged on an emergency billion-dollar loan Enron had just obtained by offering its precious pipelines as collateral. But one egregious comment Lay made that fateful October day could end up as his salvation. During the conference call with analysts, he professed the "highest faith and confidence" in the company's chief financial officer, Andrew Fastow, who the next day suddenly took what became a permanent leave of absence. Nearly three years later, Lay claims he was unaware of Fastow's misdeeds, a defense strategy casting Lay as the world's most clueless CEO, sincerely waving his pom-poms as his team got crushed.

    Government prosecutors are patting one another on the back for finally hooking the biggest fish in an investigation into what U.S. Deputy Attorney General James Comey described last week as Enron's "spectacular fall from grace." Lay, 62, was the public face of the once stodgy pipeline firm that morphed into the seventh biggest U.S. company by trading natural gas and megawatts of power. A minister's son with a Ph.D. in economics, Lay was spared being charged with approving Enron's now famous off-the-books partnerships that hid so much debt for so long. And unlike the two former colleagues he will be tried with — Enron's onetime CEO Jeffrey Skilling and chief accounting officer Richard Causey — Lay wasn't charged with insider trading by the Justice Department (although last week the Securities and Exchange Commission did so in a separate, $90 million suit in civil court, where the standard of proof is less stringent). Instead, the bulk of the charges against Lay allege that he helped keep the deceit alive after he resumed his role as CEO in August 2001, when Skilling abruptly resigned. The remaining charges deal with an obscure bank-fraud rule involving Lay's personal-loan applications. "I have to go home and look up something called a Reg U," Lay's attorney griped. "That's a stretch."

    The case won't be easy to win. Lay's claim that he believed the company stock was a good buy is bolstered by the fact that he kept purchasing more and sold shares only when forced to by margin calls. Jurors' heads will be spinning from all the byzantine financial data. And, says Houston securities litigator Thomas Ajamie, "the complexity of this case will work in the defense's favor."

    Even before the Enron accounting scandal started to unravel, many people were calling for Lay's head. His company was suspected of wrongdoing in early 2001, during the California energy crisis. Last month, following the release of tapes in which Enron traders gleefully spoke of ripping off Golden State grandmothers, California's attorney general sued the firm for violating the state's unfair-competition and commodities-fraud laws. After Enron collapsed, smashing the nest eggs of rank-and-file employees, political pressure to build the case against Lay intensified. One of George W. Bush's top contributors during the 2000 campaign, Lay was nicknamed "Kenny Boy" by the President. As the months went by with no indictment, Democrats in Washington grumbled that he was being insulated by the White House.

     

    "Lay Says 'Classic Run on Bank' Ruined Enron:   Ex-Chairman Uses Debut on Stand To Depict Charges as 'Ludicrous,' Blames Fastow, Media, Traders," by John R. Emswhiller and Gary McWilliams, The Wall Street Journal,  April 25, 2006; Page C1 --- http://online.wsj.com/article/SB114588472143834040.html?mod=todays_us_money_and_investing

    Making the most important public appearance of a long public life, former Enron Corp. Chairman Kenneth Lay took the witness stand at his criminal trial, where he admitted to mistakes but firmly denied any wrongdoing in running the energy giant.

    He blamed Enron's December 2001 collapse on deceitful underlings, hostile stock traders and damaging news coverage by The Wall Street Journal. Those forces collided to provoke what he called a "classic run on the bank" that set the stage for the company's bankruptcy filing. He also portrayed himself as a man still somewhat stunned by his fall from a pinnacle where he used to rub shoulders with world leaders and other corporate titans. Of all the things he had speculated about in his life, being a criminal defendant "was nowhere in any of them," he said.

    Whether the jury accepts Mr. Lay's version of events could go a long way toward determining whether he and former Enron President Jeffrey Skilling are convicted in their federal conspiracy and fraud trial here. A string of government witnesses, including several former Enron executives, have testified that the defendants knew about manipulations of the company's finances and lied to the public about its condition.

    Mr. Skilling completed eight days of testimony last week, in the first phase of what is viewed as the crucial period of the two men's joint defense strategy. If anything, Mr. Lay's performance is even more important, though it is expected to be only about half as long. He is Enron's best-known figure and is widely considered a more affable, and potentially more likable, figure to jurors than the more-intense Mr. Skilling. A major part of Mr. Lay's responsibilities in Enron's last years was to serve as the company's public face.

    Shortly after court began yesterday morning, the 64-year-old Mr. Lay strode to the witness box, stopping to raise his right hand well above his head as Judge Sim Lake administered the witness oath. When asked if he promised to tell the truth, he answered with a clear, almost resounding "I do."

    Continued in article

    "Skilling Defends Enron, Himself: In First Testimony, Ex-President Denies Plot to Defraud Investors; 'I Will Fight' Until 'Day I Die'," by John r. Emshwiller and Gary McWilliams, The Wall Street Journal, April 11, 2006; Page C1 --- http://online.wsj.com/article/SB114467495953621753.html?mod=todays_us_money_and_investing

    Mr. Skilling Monday dived straight into an aggressive defense of both himself and Enron that contrasted with its public image as a symbol of corporate scandal. Mr. Skilling talked of his pride in Enron's growth and the quality of its employees, even the excitement he felt walking each day into Enron's gleaming headquarters tower here. "We were making the world better," Mr. Skilling said.

    Challenging claims made by several government witnesses, Mr. Skilling said he never told any of his subordinates at Enron to lie or in any way manipulate the company's financial statements. However, he also described several of the key witnesses as honest men. The defense argues that these witnesses succumbed to government pressure and pleaded guilty to crimes that they didn't commit.

    He insisted that Enron was a successful and vibrant company that was undermined by a market panic partly sparked by several Wall Street Journal articles in October 2001. Monday, Paul E. Steiger, the Journal's managing editor, said the paper's reporters "were leaders in uncovering the accounting scandal at Enron. We are proud of our work."

    Continued in article

    "Enron Prosecutor Attacks Theory of 2001 Collapse," by Alexei Barrionuevo and Simon Romero, The New York Times, April 27, 2006 --- Click Here

    How Enron Fraudulently Used Derivative Financial Instruments: Frank Partnoy's Testimony Before the United States Senate
    I am submitting testimony in response to this Committee’s request that I address potential problems associated with the unregulated status of derivatives used by Enron Corporation. . . . In short, Enron makes Long-Term Capital Management look like a lemonade stand.

    Testimony of Frank Partnoy Professor of Law, University of San Diego School of Law Hearings before the United States Senate Committee on Governmental Affairs, January 24, 2002 --- http://www.senate.gov/~gov_affairs/012402partnoy.htm 

    Enron Declared Bankruptcy in 2001
    History of the Rise and Fall of Enron --- http://www.trinity.edu/rjensen/FraudEnron.htm
    Bob Jensen's Enron Quiz --- http://www.trinity.edu/rjensen/FraudEnronQuiz.htm
    And don't forget about the Enron home video starring some of the real players (including Jeff Skilling) before they got caught --- http://www.trinity.edu/rjensen/FraudEnron.htm#HFV


    2001
    Energy companies somewhat similar to Enron were also using SPEs and other ploys to allegedly hide debt. One such company was the questionable structuring of the Harken Anadarko Partnership (HAP that involved both Harvard University and George W. Bush before he became President of the U.S. --- http://www.wsws.org/articles/2002/oct2002/hark-o19.shtml

    Many executives allegedly misstate earnings upward and debt downward to collect bonuses, stock options, and stock sales before restating earnings later on without having to repay their allegedly ill-gotten gains --- http://aaahq.org/AM2006/display.cfm?Filename=SubID_0847.pdf&MIMEType=application%2Fpdf

    Infectious Greed:  How Deceit and Risk Corrupted the Financial Markets  (Henry Holt and Company, 2003, Page 351, ISBN 0-8050-7510-0)

    The range of financial malfeasance and manipulation was fast. Energy companies, such as Dynegy, El Paso, and Williams, did the same complex financial deals (particularly using SPEs) Andy Fastow engineered at Enron. Telecommunication s firms, such as Global Crossing and WorldCom, fell into bankruptcy after it became clear they, too, had been cooking their books. Financial firms were victims as well as aiders-and-abettors. PNC Financial, a major bank, settled SEC charges that it abused off-balance-sheet deals and recklessly overstated its 2001 earnings by more than half. A rogue trader at Allfirst Financial, a large Irish bank, lost $750 million in a flurry of derivatives trading that put Nick Leeson of Barings to shame. And so on, and so on.

    . . .

    As with the prior financial scandals, substantial losses were related to over-the-counter derivatives. There were prepaid swaps, in which a company received an up-rong payment resembling a loan from a bank, but did not record its future obligations to repay the bank as a liability. There were swaps of Indefeasible Rights of Use, or IRUs, long-term rights to use bandwidth on a telecommunications company's fiber-optic network, which were similar to the long-term energy derivatives Enron traded --- and just as ripe for abuse. And there were more Soecial Purpose Entities, created by Wall Street banks.

    Bob Jensen's threads on off-balance-sheet financing OBSF) are at http://www.trinity.edu/rjensen/Theory01.htm#OBSF2
    The above site also discusses in-substance defeasance.

    Infectious Greed:  How Deceit and Risk Corrupted the Financial Markets  (Henry Holt and Company, 2003, Page 364, ISBN 0-8050-7510-0)

    Global Crossings then used the "Cash Revenue" number to calculate another accounting fiction, "Adusted EBITDA," a manufactured number that included EBITDA --- the measure of accounting earnings --- plus the "non-deferred revenue," terms that referred to Indefeasible Rights of Use, or IRUs, swaps. In other words, Global Crossing's "Adjusted EBITDA" was a measure of the firm's income that included up-front revenue from the IRU swaps, but spread expenses over time.

    . . .

    The fictitious gains from IRU swaps could not continue indefinitely without real profits to replace them, and on October 4, 2001 --- less than three weeks before Ken Lay's fateful conference call with Enron's analysts and investors --- Global Crossing announced that it would not meet analysts' earnings estimates. As word spread abou the way the firm had recorded revenues (up front) and expenses (over time) from IRU swaps, investors abandoned the stock . . .The end was sudden. and Global Crossing filed for bankruptcy on January 28, 2002 . . .
    Jensen Comment
    The mastermind of the accounting fraud, CEO Gary Winnick, lost a bit, but he managed to hang on to most of his ill-gotten billions of dollars.

    You can read more about how Global Crossing used IRUs at http://www.springerlink.com/content/m5026u5707u0m880/ .


    2001
    Chris Ayres and Clive Mathieson, London Times Online, March 1, 2002 --- http://www.thetimes.co.uk/article/0,,5-222235,00.html 

    In particular, it has raised awareness of “hollow swaps”, where two telecoms companies exchange identical amounts of network capacity, then book the purchase cost as capital expense and the sale as revenue. Although C&W says it does not use hollow swaps, it has recently admitted to using another controversial accounting method to book the sale of  Indefeasible Rights of Use, or IRUs, contracts. C&W booked the contracts, which give access to its telecoms network, as upfront revenue even though they were spread over periods of up to 15 years. Such deals — which were outlawed in 1999 by regulators in America — boosted C&W’s revenues by £373 million in 2001.


    2001

    The Largest Earnings Management Fraud in History
    and Congressional Efforts to Cover it Up

    Without trying to place the blame on Democrats or Republicans, here are some of the facts that led to the eventual fining of Fannie Mae executives for accounting fraud and the firing of KPMG as the auditor on one of the largest and most lucrative audit clients in the history of KPMG. The restated earnings purportedly took upwards of a million journal entries, many of which were re-valuations of derivatives being manipulated by Fannie Mae accountants and auditors (PwC was charged with overseeing the financial statement revisions. 

     

    Fannie Mae may have conducted the largest earnings management scheme in the history of accounting.
     
     
    . . . flexibility also gave Fannie the ability to manipulate earnings to hit -- within pennies -- target numbers for executive bonuses. Ofheo details an example from 1998, the year the Russian financial crisis sent interest rates tumbling. Lower rates caused a lot of mortgage holders to prepay their existing home mortgages. And Fannie was suddenly facing an estimated expense of $400 million.

    Well, in its wisdom, Fannie decided to recognize only $200 million, deferring the other half. That allowed Fannie's executives -- whose bonus plan is linked to earnings-per-share -- to meet the target for maximum bonus payouts. The target EPS for maximum payout was $3.23 and Fannie reported exactly . . . $3.2309. This bull's-eye was worth $1.932 million to then-CEO James Johnson, $1.19 million to then-CEO-designate Franklin Raines, and $779,625 to then-Vice Chairman Jamie Gorelick.

    That same year Fannie installed software that allowed management to produce multiple scenarios under different assumptions that, according to a Fannie executive, "strengthens the earnings management that is necessary when dealing with a volatile book of business." Over the years, Fannie designed and added software that allowed it to assess the impact of recognizing income or expense on securities and loans. This practice fits with a Fannie corporate culture that the report says considered volatility "artificial" and measures of precision "spurious."

    This disturbing culture was apparent in Fannie's manipulation of its derivative accounting. Fannie runs a giant derivative book in an attempt to hedge its massive exposure to interest-rate risk. Derivatives must be marked-to-market, carried on the balance sheet at fair value. The problem is that changes in fair-value can cause some nasty volatility in earnings.

    So, Fannie decided to classify a huge amount of its derivatives as hedging transactions, thereby avoiding any impact on earnings. (And we mean huge: In December 2003, Fan's derivatives had a notional value of $1.04 trillion of which only a notional $43 million was not classified in hedging relationships.) This misapplication continued when Fannie closed out positions. The company did not record the fair-value changes in earnings, but only in Accumulated Other Comprehensive Income (AOCI) where losses can be amortized over a long period.

    Fannie had some $12.2 billion in deferred losses in the AOCI balance at year-end 2003. If this amount must be reclassified into retained earnings, it might punish Fannie's earnings for various periods over the past three years, leaving its capital well below what is required by regulators.

    In all, the Ofheo report notes, "The misapplications of GAAP are not limited occurrences, but appear to be pervasive . . . [and] raise serious doubts as to the validity of previously reported financial results, as well as adequacy of regulatory capital, management supervision and overall safety and soundness. . . ." In an agreement reached with Ofheo last week, Fannie promised to change the methods involved in both the cookie-jar and derivative accounting and to change its compensation "to avoid any inappropriate incentives."

    But we don't think this goes nearly far enough for a company whose executives have for years derided anyone who raised a doubt about either its accounting or its growing risk profile. At a minimum these executives are not the sort anyone would want running the U.S. Treasury under John Kerry. With the Justice Department already starting a criminal probe, we find it hard to comprehend that the Fannie board still believes that investors can trust its management team.

    Fannie Mae isn't an ordinary company and this isn't a run-of-the-mill accounting scandal. The U.S. government had no financial stake in the failure of Enron or WorldCom. But because of Fannie's implicit subsidy from the federal government, taxpayers are on the hook if its capital cushion is insufficient to absorb big losses. Private profit, public risk. That's quite a confidence game -- and it's time to call it.

     

    **********************************

    :"Sometimes the Wrong 'Notion':   Lender Fannie Mae Used A Too-Simple Standard For Its Complex Portfolio," by Michael MacKenzie, The Wall Street Journal, October 5, 2004, Page C3 

    Lender Fannie Mae Used A Too-Simple Standard For Its Complex Portfolio

    What exactly did Fannie Mae do wrong?

    Much has been made of the accounting improprieties alleged by Fannie's regulator, the Office of Federal Housing Enterprise Oversight.

    Some investors may even be aware the matter centers on the mortgage giant's $1 trillion "notional" portfolio of derivatives -- notional being the Wall Street way of saying that that is how much those options and other derivatives are worth on paper.

    But understanding exactly what is supposed to be wrong with Fannie's handling of these instruments takes some doing. Herewith, an effort to touch on what's what -- a notion of the problems with that notional amount, if you will.

    Ofheo alleges that, in order to keep its earnings steady, Fannie used the wrong accounting standards for these derivatives, classifying them under complex (to put it mildly) requirements laid out by the Financial Accounting Standards Board's rule 133, or FAS 133.

    For most companies using derivatives, FAS 133 has clear advantages, helping to smooth out reported income. However, accounting experts say FAS 133 works best for companies that follow relatively simple hedging programs, whereas Fannie Mae's huge cash needs and giant portfolio requires constant fine-tuning as market rates change.

    A Fannie spokesman last week declined to comment on the issue of hedge accounting for derivatives, but Fannie Mae has maintained that it uses derivatives to manage its balance sheet of debt and mortgage assets and doesn't take outright speculative positions. It also uses swaps -- derivatives that generally are agreements to exchange fixed- and floating-rate payments -- to protect its mortgage assets against large swings in rates.

    Under FAS 133, if a swap is being used to hedge risk against another item on the balance sheet, special hedge accounting is applied to any gains and losses that result from the use of the swap. Within the application of this accounting there are two separate classifications: fair-value hedges and cash-flow hedges.

    Fannie's fair-value hedges generally aim to get fixed-rate payments by agreeing to pay a counterparty floating interest rates, the idea being to offset the risk of homeowners refinancing their mortgages for lower rates. Any gain or loss, along with that of the asset or liability being hedged, is supposed to go straight into earnings as income. In other words, if the swap loses money but is being applied against a mortgage that has risen in value, the gain and loss cancel each other out, which actually smoothes the company's income.

    Cash-flow hedges, on the other hand, generally involve Fannie entering an agreement to pay fixed rates in order to get floating-rates. The profit or loss on these hedges don't immediately flow to earnings. Instead, they go into the balance sheet under a line called accumulated other comprehensive income, or AOCI, and are allocated into earnings over time, a process known as amortization.

    Ofheo claims that instead of terminating swaps and amortizing gains and losses over the life of the original asset or liability that the swap was used to hedge, Fannie Mae had been entering swap transactions that offset each other and keeping both the swaps under the hedge classifications. That was a no-go, the regulator says.

    "The major risk facing Fannie is that by tainting a certain portion of the portfolio with redesignations and improper documentation, it may well lose hedge accounting for the whole derivatives portfolio," said Gerald Lucas, a bond strategist at Banc of America Securities in New York.

    The bottom line is that both the FASB and the IASB must someday soon take another look at how the real world hedges portfolios rather than individual securities.  The problem is complex, but the problem has come to roost in Fannie Mae's $1 trillion in hedging contracts.  How the SEC acts may well override the FASB.  How the SEC acts may be a vindication or a damnation for Fannie Mae and Fannie's auditor KPMG who let Fannie violate the rules of IAS 133.

     

    Video on the efforts of some members of Congress seeking to cover up accounting fraud at Fannie Mae ---
    http://www.youtube.com/watch?v=1RZVw3no2A4

    Peter, Paul, and Barney: An Essay on 2008 U.S. Government Bailouts of Private Companies ---
    http://www.trinity.edu/rjensen/2008Bailout.htm

     


    2001
    "Does the use of Financial Derivatives Affect Earnings Management Decisions," by Jan Barton, The Accounting Review, January 2001, pp. 1-26.

    I present evidence consistent with managers using derivatives and discretionary accruals as partial substitutes for smoothing earnings. Using 1994-1996 data for a sample of Fortune 500 firms, I estimate a set of simultaneous equations that captures managers' incentives to maintain a desired level of earnings volatility through hedging and accrual management. These incentives include increasing managerial compensation and wealth, reducing corporate taxes and debt financing costs, avoiding underinvestment and earnings surprises, and mitigating volatility caused by low diversification. After controlling for such incentives, I find significant negative association between derivatives' notional amounts and proxies for the magnitude of discretionary accruals.


    2001
    Infectious Greed:  How Deceit and Risk Corrupted the Financial Markets  (Henry Holt and Company, 2003, Page 380, ISBN 0-8050-7510-0)

    In its 2001 annual report --- issued in 2002 --- General Electric comforted its investors by stating, "As a matter of policy, neither GE nor GECS [GE Capital] engages in derivatives trading, derivatives market-making, or other speculative activities." But in a footnote, General Electric noted that, because of changes in the way it accounted for its derivatives operations, it had reduced its earnings by $501 million, and reduced shareholder euity by $1.3 billion. These numbers were roughly the same as the restatement Enron had made in 2001, yet investors didn't seem to care (in GE's case).


    2001
    Infectious Greed:  How Deceit and Risk Corrupted the Financial Markets
      (Henry Holt and Company, 2003, Pages 385 &389, ISBN 0-8050-7510-0)

    The second type of credit derivative --- the Collateralized Debt Obligation  (CDO) --- posed even greater dangers to the global economy. In a standard CDO, a financial institution sold debt (loans or bonds) to a Special Purpose Entity, which then split the debt into p9ces by issuing new securities linked to each piece. Some of the pieces were of higher quality; some were of lower quality. The credit-rating agencies gave investment-grade ratings to all except the lowest-quality piece. By 2002, there were more than a half a trillion dollars of CDOs.

    . . .

    .No one had paid much attention to the first warning that CDOs threatened the health of the global economy. In July 2001 --- two months before Jeff Slilling had resigned from Enron, and long before investors learned about the accounting problems at Global Crossing and WorldCom --- American Express, the U.S. financial services conglomerate had calmly announced that it would take an $825 million pretax charge to write down the value of investments in high-yield bonds and Collateralized Debt Obligations. It all sounded much too esoteric to matter to average investors. The media brushed off the details by focusing on the junk bonds involved in the various deals, and commentators seem to agree that theese losses were just a minor consequence of the explosion of financial innovation.

    . . .

    Then there was the stunning public admission by the chairman of American Express, Kenneth Cheault, that his firm "did not comprehend the risk" of these investments.  What?

    .Bob Jensen's threads on how to account for CDOs are at http://www.trinity.edu/rjensen/Theory01.htm#CDO


    2001
    The IASC was upgraded to the International Accounting Standards Board (IASB) in 2001 --- http://en.wikipedia.org/wiki/International_Accounting_Standards_Board
    The IASB home page is at http://www.iasb.org/Home.htm


    2001
    Video:  Jim Turley at USC Leventhal School of Accounting --- http://www.youtube.com/watch?v=Nqs7SwbZmUo
     


    1992

    The International Organization of Securities Commissions (IOSCO) commenced a serious effort to support cross-border accounting standards --- http://www.iosco.org/library/resolutions/pdf/IOSCORES6.pdf
    This is one of the first major steps toward achieving international consistency in accounting for derivative financial instruments and hedging activities.

    1. The members of IOSCO believe it is important to identify ways to facilitate crossborder offerings by multinational issuers. An important factor in encouraging such offerings is the development of a generally accepted body of international standards on auditing which could be used for cross-border offerings and continuous reporting by foreign issuers.

    2. Auditing standards play a critical role in the protection of investors within each country's domestic securities market and are an important part of a country's securities regulatory system. Securities regulatory authorities have responsibility for the development and implementation of that securities regulatory system. Securities regulatory authorities therefore have an important responsibility to ensure that auditing standards are responsive to the need for investor protection.

    3. For several years, the Technical Committee, through its Working Party No. 1 and Sub-Committee on Accounting and Auditing, has worked closely with the International Auditing Practices Committee (the "IAPC") of the International Federation of Accountants ("IFAC") in developing IAPC's international standards on auditing. The Technical Committee has provided commentary, critiques and proposed changes to such auditing standards to ensure that such standards adequately address securities regulators' concerns with investor protection.

    4. After a full review of the IAPC's proposed auditing standards, the Technical Committee believes that the IAPC auditing standards (with the inclusion of the current exposure drafts of three standards that are expected to be finalized by early 1993) set forth on Attachment A represent a comprehensive set of auditing standards and that audits conducted in accordance with these standards could be relied upon by securities regulatory authorities for multinational reporting purposes. It should be noted that the Technical Committee is not making any recommendation with respect to the form of the auditors' report or the IFAC standards relating to auditor qualifications and independence. At present there is not a consensus that the standards in these three areas adequately address the concerns raised by securities regulatory authorities. Working Party No. 1 is continuing to work with the IAPC on these matters. It will also monitor future developments and report periodically to the Technical Committee.

    5. In light of the foregoing and based on the recommendation of the Technical Committee, IT IS HEREBY RESOLVED that the Presidents' Committee recommends that the members of IOSCO:

    a. accept the International Standards on Auditing identified on Attachment A hereto as an acceptable basis for use in cross-border offerings and continuous reporting by foreign issuers; and

     b. take all steps that are necessary and appropriate in their respective home jurisdictions to accept audits conducted in accordance with International Standards on Auditing as an alternative to domestic auditing standards in connection with cross-border offerings and continuous reporting by foreign issuers.

    From Paul Pacter:  IOSCO AGREEMENT (July 1995) --- http://www.trinity.edu/rjensen/acct5341/speakers/pacter.htm#001 

    The [IASC] Board has developed a work plan that the Technical Committee agrees will result, upon successful completion, in IAS comprising a comprehensive core set of standards. Completion of comprehensive core standards that are acceptable to the [IOSCO] Technical Committee will allow the Technical Committee to recommend endorsement of IAS for cross border capital raising and listing purposes in all global markets. IOSCO has already endorsed IAS 7, Cash Flow Statements, and has indicated to the IASC that 14 of the existing International Accounting Standards do not require additional improvement, providing that the other core standards are successfully completed.

    Also see the IOSCO President's Committee year 2000 resolutions --- http://www.iosco.org/library/resolutions/pdf/IOSCORES19.pdf

    Eventually in 2001 IOSCO recommended that its members allow multinational issuers to use 30 IASC standards in cross-border offerings and listing. This action tended to improve the status and acceptance of IASC standards even though it was only a "recommendation" that could easily be overridden by any member nation's law which in most instances required adherence to that nation's standards --- http://en.wikipedia.org/wiki/International_Organization_of_Securities_Commissions
    The IOSCO homepage is at http://www.iosco.org/

    Paul is the Webmaster of The IAS Plus International Standards Blog of Deloitte. That blog provides an excellent summary of the history of IAS 39 and all its amendments to date --- http://www.iasplus.com/standard/ias39.htm
     


    2001
    Stanford University Law School Securities Class Action Clearinghouse
    --- http://securities.stanford.edu/
    Index for 1996-? --- http://securities.stanford.edu/companies.html

    Some of the many, many lawsuits settled by auditing firms can be found at http://www.trinity.edu/rjensen/Fraud001.htm

    2002
    Infectious Greed:  How Deceit and Risk Corrupted the Financial Markets  (Henry Holt and Company, 2003, Page 350, ISBN 0-8050-7510-0)

    Just as the interest rate hikes of early 1994 had uncovered hundreds of derivatives bets at major institutions, the collapse of Enron exposed widespread risks and deceitful practices of the world's leading corporations. Any investor who read a newspaper in 2002 knew about financial scandals at companies ranging from Adelphia to WroldCom, from Anadarko to Xerpx.

    By the end of 2002, the surfeit of information about complex dealings and surprise losses became, for many investors, like financial white noise. On average, one company restated its financial every day. There was a billion-dollar collapse every few weeks. Congressional inquiries into the Enron, Global Crossing, and WorldCom scandals were televised incessantly.

    At first, public officials blamed corporate executives and accounting firms. Jeffrey Skilling of Enron was publicly assiled, while other former CEOs, including Bernard Ebbers of WorldCom invoked their Fifth Amendment right against self-incrimination. Arthur Andersen was convicted of obstructing justice, PricewaterhouseCoopers  was charged with violating rules requiring auditor independence, and Congress established new penalties for top corporate executives (in the SOX Law) and additional oversight of accounting firms (in the SOX Law). Over time, the emphasis shifted from CEOs and accountants to Wall Street, as it became clear that major banks --- especially Citigroup and J.P. Morgan Chase --- were intimately involved in the various schemes.


    Sarbanes-Oxley Act (SOX or SarBox) of 2002 --- http://en.wikipedia.org/wiki/Sarbanes-Oxley_Act

    The Sarbanes-Oxley Act of 2002 (Pub.L. 107-204, 116 Stat. 745, enacted 2002-07-30), also known as the Public Company Accounting Reform and Investor Protection Act of 2002 and commonly called SOx or Sarbox; is a United States federal law enacted on July 30, 2002 in response to a number of major corporate and accounting scandals including those affecting Enron, Tyco International, Adelphia, Peregrine Systems and WorldCom. These scandals, which cost investors billions of dollars when the share prices of the affected companies collapsed, shook public confidence in the nation's securities markets. Named after sponsors Senator Paul Sarbanes (D-MD) and Representative Michael G. Oxley (R-OH), the Act was approved by the House by a vote of 423-3 and by the Senate 99-0. President George W. Bush signed it into law, stating it included "the most far-reaching reforms of American business practices since the time of Franklin D. Roosevelt."[1]

    The legislation establishes new or enhanced standards for all U.S. public company boards, management, and public accounting firms.It does not apply to privately held companies. The Act contains 11 titles, or sections, ranging from additional Corporate Board responsibilities to criminal penalties, and requires the Securities and Exchange Commission (SEC) to implement rulings on requirements to comply with the new law. Debate continues over the perceived benefits and costs of SOX. Supporters contend that the legislation was necessary and has played a useful role in restoring public confidence in the nation's capital markets by, among other things, strengthening corporate accounting controls.

    The Act establishes a new quasi-public agency, the Public Company Accounting Oversight Board, or PCAOB, which is charged with overseeing, regulating, inspecting, and disciplining accounting firms in their roles as auditors of public companies. The Act also covers issues such as auditor independence, corporate governance, internal control assessment, and enhanced financial disclosure.

    Sarbanes-Oxley Act of 2002 --- http://en.wikipedia.org/wiki/Sarbanes-Oxley_Act

    • 1 Overview
    • 2 History & context: events contributing to the adoption of SOX
      • 2.1 Timeline and passage of SOX
    • 3 Analyzing the cost-benefit of Sarbanes-Oxley
      • 3.1 The effect of SOX on non-US companies
    • 4 Implementation of Key Provisions
      • 4.1 SOX Section 302: Internal control certifications
      • 4.2 SOX Section 404: Assessment of internal control
      • 4.3 SOX 404 and smaller public companies
        • 4.3.1 SOX 404 and information technology
      • 4.4 SOX Section 802 Criminal Penalties for Violation of SOX
      • 4.5 SOX Section 1107 Criminal Penalties for Retaliation Against Whistleblowers
    • 5 Criticism
    • 6 Legislative information
    • 7 References
    • 8 See also
      • 8.1 Similar laws in other countries
    • 9 External links

    Overview

    Sarbanes-Oxley contains 11 titles that describe specific mandates and requirements for financial reporting. Each title consists of several sections, summarized below.

    • 1) Public Company Accounting Oversight Board (PCAOB)
    Title I consists of nine sections and establishes the Public Company Accounting Oversight Board , to provide independent oversight of public accounting firms providing audit services ("auditors"). It also creates a central oversight board tasked with registering auditors, defining the specific processes and procedures for compliance audits, inspecting and policing conduct and quality control, and enforcing compliance with the specific mandates of SOX.
    • 2) Auditor Independence
    Title II consists of nine sections, establishes standards for external auditor independence, to limit conflicts of interest. It also addresses new auditor approval requirements, audit partner rotation policy, conflict of interest issues and auditor reporting requirements. Section 201 of this title restricts auditing companies from doing other kinds of business apart from auditing with the same clients.
    • 3) Corporate Responsibility
    Title III consists of eight sections and mandates that senior executives take individual responsibility for the accuracy and completeness of corporate financial reports. It defines the interaction of external auditors and corporate audit committees, and specifies the responsibility of corporate officers for the accuracy and validity of corporate financial reports. It enumerates specific limits on the behaviors of corporate officers and describes specific forfeitures of benefits and civil penalties for non-compliance. For example, Section 302 implies that the company board (Chief Executive Officer, Chief Financial Officer) should certify and approve the integrity of their company financial reports quarterly in order to establish accountability.
    • 4) Enhanced Financial Disclosures
    Title IV consists of nine sections. It describes enhanced reporting requirements for financial transactions, including off-balance-sheet transactions, pro-forma figures and stock transactions of corporate officers. It requires internal controls for assuring the accuracy of financial reports and disclosures, and mandates both audits and reports on those controls. It also requires timely reporting of material changes in financial condition and specific enhanced reviews by the SEC or its agents of corporate reports.
    • 5) Analyst Conflicts of Interest
    Title V consists of only one section, which includes measures designed to help restore investor confidence in the reporting of securities analysts. It defines the codes of conduct for securities analysts and requires disclosure of knowable conflicts of interest.
    • 6) Commission Resources and Authority
    Title VI consists of four sections and defines practices to restore investor confidence in securities analysts. It also defines the SEC’s authority to censure or bar securities professionals from practice and defines conditions under which a person can be barred from practicing as a broker, adviser or dealer.
    • 7) Studies and Reports
    Title VII consists of five sections and are concerned with conducting research for enforcing actions against violations by the SEC registrants (companies) and auditors. Studies and reports include the effects of consolidation of public accounting firms, the role of credit rating agencies in the operation of securities markets, securities violations and enforcement actions, and whether investment banks assisted Enron, Global Crossing and others to manipulate earnings and obfuscate true financial conditions.
    • 8) Corporate and Criminal Fraud Accountability
    Title VIII consists of seven sections and it also referred to as the “Corporate and Criminal Fraud Act of 2002”. It describes specific criminal penalties for fraud by manipulation, destruction or alteration of financial records or other interference with investigations, while providing certain protections for whistle-blowers.
    • 9) White Collar Crime Penalty Enhancement
    Title IX consists of two sections. This section is also called the “White Collar Crime Penalty Enhancement Act of 2002.” This section increases the criminal penalties associated with white-collar crimes and conspiracies. It recommends stronger sentencing guidelines and specifically adds failure to certify corporate financial reports as a criminal offense.
    • 10) Corporate Tax Returns
    Title X consists of one section. Section 1001 states that the Chief Executive Officer should sign the company tax return.
    • 11) Corporate Fraud Accountability
    Title XI consists of seven sections. Section 1101 recommends a name for this title as “Corporate Fraud Accountability Act of 2002”. It identifies corporate fraud and records tampering as criminal offenses and joins those offenses to specific penalties. It also revises sentencing guidelines and strengthens their penalties. This enables the SEC to temporarily freeze large or unusual payments.

    History

    A variety of complex factors created the conditions and culture in which a series of large corporate frauds occurred between 2000-2002. The spectacular, highly-publicized frauds at Enron (see Enron scandal), WorldCom, and Tyco exposed significant problems with conflicts of interest and incentive compensation practices. These frauds and others resulted in over U.S. $500 billion in market value declines. The analysis of their complex and contentious root causes contributed to the passage of SOX in 2002. Specific contributing factors and events included:

    • Boardroom failures: Boards of Directors, specifically Audit Committees, are charged with establishing oversight mechanisms for financial reporting in U.S. corporations on the behalf of investors. These scandals identified Board members who either did not exercise their responsibilities or did not have the expertise to understand the complexities of the businesses. In many cases, Audit Committee members were not truly independent of management.
    • Auditor conflicts of interest: Prior to SOX, auditing firms, the primary financial "watchdogs" for investors, also performed significant non-audit or consulting work for the companies they audited. Many of these consulting agreements were far more lucrative than the auditing engagement. This presented at least the appearance of a conflict of interest. For example, challenging the company's accounting approach might damage a client relationship, conceivably placing a significant consulting arrangement at risk.
    • Securities industry conflicts of interest: The roles of securities analysts, who make buy and sell recommendations on company stocks and bonds, and investment bankers, who help provide companies loans or handle mergers and acquisitions, provide opportunities for conflicts. Similar to the auditor conflict, issuing a buy or sell recommendation on a stock while providing lucrative investment banking services creates at least the appearance of a conflict of interest.
    • Banking practices: Lending to a firm sends signals to investors regarding the firm's risk. In the case of Enron, several major banks provided large loans to the company without understanding, or while ignoring, the risks of the company. Investors of these banks and their clients were hurt by such bad loans, resulting in large settlement payments by the banks. Others interpreted the willingness of banks to lend money to the company as an indication of its health and integrity, and were led to invest in Enron as a result. These investors were hurt as well.
    • Internet bubble: Investors had been stung in 2000 by the sharp declines in technology stocks and to a lesser extent, by declines in the overall market. Certain mutual fund managers were alleged to have advocated the purchasing of particular technology stocks, while quietly selling them. The losses sustained also helped create a general anger among investors.
    • Executive compensation: Stock option and bonus practices, combined with volatility in stock prices for even small earnings "misses," resulted in pressures to manage earnings. Stock options were not treated as compensation expense by companies, encouraging this form of compensation. With a large stock-based bonus at risk, managers were pressured to meet their targets.

    March 13, 2009 message from Zafar Khan

    Why was Sarbanes-Oxley enacted?

    Zafar Khan, Ph.D.
    Professor
    Eastern Michigan University

    March 14, 2009 reply from Bob Jensen

    Hi Zafar,

    Sarbanes (SOX) was enacted to keep investors from abandoning the U.S. stock market after enormous scandals like Enron, WorldCom, and other huge scandals that revealed CPA audits themselves were becoming both substandard and non-profitable --- http://www.trinity.edu/rjensen/FraudEnron.htm

    To make money, auditing firms themselves were profiting from irresponsible audit cost cutting and non-audit consulting that compromised their auditing independence. Inside corporations, internal controls for responsible financial reporting had broken down or never existed in the first place.

    Sarbanes forced auditors to become more independent and also made it possible to double or triple audit fees, thereby restoring auditing to profitable services rather than services that lost money for auditing firms trying to be responsible auditors.

    SOX also created the PCAOB that got serious about reviewing auditor performance (including fining Deloitte a million dollars). Many of the large and smaller CPA firms failed the PCAOB tests early on and soon cleaned up their audit practices with the PCAOB breathing down their backs.

    Among other things SOX increased government funding for the SEC and the FASB (which before SOX received no taxpayer funding). This, in turn, made the FASB less dependent upon sales of publications. The FASB then made many publications free electronically, most notably free distribution of standards and interpretations. The IASB, sadly, still depends upon publication revenue such that IFRS are not free unless you play games like download the equivalent Hong Kong accounting standards.

    See http://en.wikipedia.org/wiki/Sarbanes_and_Oxley

    A variety of complex factors created the conditions and culture in which a series of large corporate frauds occurred between 2000-2002. The spectacular, highly-publicized frauds at Enron (see Enron scandal), WorldCom, and Tyco exposed significant problems with conflicts of interest and incentive compensation practices. The analysis of their complex and contentious root causes contributed to the passage of SOX in 2002. In a 2004 interview, Senator Paul Sarbanes stated:

     

    The Senate Banking Committee undertook a series of hearings on the problems in the markets that had led to a loss of hundreds and hundreds of billions, indeed trillions of dollars in market value. The hearings set out to lay the foundation for legislation. We scheduled 10 hearings over a six-week period, during which we brought in some of the best people in the country to testify...The hearings produced remarkable consensus on the nature of the problems: inadequate oversight of accountants, lack of auditor independence, weak corporate governance procedures, stock analysts' conflict of interests, inadequate disclosure provisions, and grossly inadequate funding of the Securities and Exchange Commission.

     

    • Auditor conflicts of interest: Prior to SOX, auditing firms, the primary financial "watchdogs" for investors, were self-regulated. They also performed significant non-audit or consulting work for the companies they audited. Many of these consulting agreements were far more lucrative than the auditing engagement. This presented at least the appearance of a conflict of interest. For example, challenging the company's accounting approach might damage a client relationship, conceivably placing a significant consulting arrangement at risk, damaging the auditing firm's bottom line.
       
    • Boardroom failures: Boards of Directors, specifically Audit Committees, are charged with establishing oversight mechanisms for financial reporting in U.S. corporations on the behalf of investors. These scandals identified Board members who either did not exercise their responsibilities or did not have the expertise to understand the complexities of the businesses. In many cases, Audit Committee members were not truly independent of management.
       
    • Securities analysts' conflicts of interest: The roles of securities analysts, who make buy and sell recommendations on company stocks and bonds, and investment bankers, who help provide companies loans or handle mergers and acquisitions, provide opportunities for conflicts. Similar to the auditor conflict, issuing a buy or sell recommendation on a stock while providing lucrative investment banking services creates at least the appearance of a conflict of interest.
       
    • Inadequate funding of the SEC: The SEC budget has steadily increased to nearly double the pre-SOX level. In the interview cited above, Sarbanes indicated that enforcement and rule-making are more effective post-SOX.
       
    • Banking practices: Lending to a firm sends signals to investors regarding the firm's risk. In the case of Enron, several major banks provided large loans to the company without understanding, or while ignoring, the risks of the company. Investors of these banks and their clients were hurt by such bad loans, resulting in large settlement payments by the banks. Others interpreted the willingness of banks to lend money to the company as an indication of its health and integrity, and were led to invest in Enron as a result. These investors were hurt as well.
       
    • Internet bubble: Investors had been stung in 2000 by the sharp declines in technology stocks and to a lesser extent, by declines in the overall market. Certain mutual fund managers were alleged to have advocated the purchasing of particular technology stocks, while quietly selling them. The losses sustained also helped create a general anger among investors.
       
    • Executive compensation: Stock option and bonus practices, combined with volatility in stock prices for even small earnings "misses," resulted in pressures to manage earnings. Stock options were not treated as compensation expense by companies, encouraging this form of compensation. With a large stock-based bonus at risk, managers were pressured to meet their targets.

     

    Pay Me More and More and More
    Sadly, SOX did not attack the root problems that led to the subsequent subprime lending scandals. These root problems included pay-for-performance compensation plans that motivated mortgage brokers, real estate appraisers, banks, and investment banks to screw both shareholders and home owners.

    Pass the Trash
    Added to this was Congressional pressure on Fannie Mae and Freddie Mack to buy hopeless mortgages that had almost no chance of being repaid. Banks commenced a practice of passing the trash to Freddie, Fannie, and Wall Street investment banks that, in turn, passed the trash to their customers in CDOs that were intended to diversify the bad loan risks (but failed to do so when the real estate bubble burst).

    SOX has worked in countless ways, but not all ways
    There are countless success stories where SOX led to better internal controls and better auditing with more substantive testing in place of lousy analytical reviews. However, SOX did almost nothing to prevent fraud in the mortgage brokering and banking sectors.

    You can read more about subprime sleaze at http://www.trinity.edu/rjensen/2008Bailout.htm#Sleaze

    You can read more about auditing professionalism at http://www.trinity.edu/rjensen/Fraud001.htm#Professionalism

    Fiduciaries turned into whores
    One of the most sad things for me is the way that CPA auditing firms failed to signal the public that banks were filling up on toxic loans. Equally unprofessional were the credit rating agencies like Standard and Poors and Moody’s that in essence became Wall Street’s whores.

    Why regulations fail and succeed in the turning of the carousel
    The main problem with government regulations on industry is that industry eventually runs the regulators (e.g., the Federal Reserve, SEC, FDA, FAA, FCC, etc.) until some enormous scandals force the regulators to use the powers entrusted to them. Then we get new regulations that industry eventually figures out how to circumvent. Then we wait for more huge scandals. And so the carousel goes round and round.

    Socialism bypasses the regulation process by owning and running the industries. Then the abuses really begin
    The inherent vice of capitalism is the unequal sharing of the blessings. The inherent blessing of socialism is the equal sharing of misery.
    Winston Churchill

    May 14, 2009 reply from Zafar Khan [zkhan@EMICH.EDU]

    Hi Bob, one can always depend upon you to set the record straight. Otherwise, some might continue to believe that this (SOX) was another gratuitous government intervention to disrupt the smooth functioning of our self correcting financial markets.

    I also read in a recent post that the government should not do anything about executive compensation despite the obscene abuse of power by the executives of public companies who have enriched themselves while running their companies into the ground because the market will in the end sort it out. My humble response to that is dream on.

    Zafar Khan, Ph.D.
    Professor
    Eastern Michigan University

    March 15, 2009 reply from Bob Jensen

    Hi again Zafar,

    After the fall of Andersen you would've thought CPA auditors would've "self corrected" without having SOX since their reputations had hit bottom.

    In 2003 a former professor of accounting at the University of Illinois and long-time executive partner with Andersen told accounting professors that the CPA firm executives "still didn't get it." This is probably why we needed SOX and the PCAOB to help them "get it." Art Wyatt’s plenary session speech at the 2003 American Accounting Association annual meetings is at http://aaahq.org/AM2003/WyattSpeech.pdf
    Art is also a former AAA President and a member of the Accounting Hall of Fame. His opinions have a lot of clout in both the CPA profession and academe.

    From “Topics for Class Debate” at http://www.trinity.edu/rjensen/FraudRotten.htm
    This might be a good topic of debate for an ethics and/or fraud course.  The topic is essentially the problem of regulating and/or punishing many for the egregious actions of a few.  The best example is the major accounting firm of Andersen in which 84,000 mostly ethical and highly professional employees lost their jobs when the firm's leadership repeatedly failed to take action to prevent corrupt and/or incompetent audits of a small number audit partners.  Clearly the firm's management failed and deserves to be fired and/or jailed for obstruction of justice and failure to protect the public in general and 83,900 Andersen employees.  A former Andersen executive partner, Art Wyatt, contends that Andersen's leadership did not get the message and that leadership in today's leading CPA firms is still not (just before SOX) getting the message --- http://aaahq.org/AM2003/WyattSpeech.pdf 

    Bob Jensen's threads on auditing professionalism are at http://www.trinity.edu/rjensen/Fraud001.htm#Professionalism

     


    2002
    How Enron Fraudulently Used Derivative Financial Instruments: Frank Partnoy's Testimony Before the United States Senate

    I am submitting testimony in response to this Committee’s request that I address potential problems associated with the unregulated status of derivatives used by Enron Corporation. . . . In short, Enron makes Long-Term Capital Management look like a lemonade stand.

    Testimony of Frank Partnoy Professor of Law, University of San Diego School of Law Hearings before the United States Senate Committee on Governmental Affairs, January 24, 2002 --- http://www.senate.gov/~gov_affairs/012402partnoy.htm 
    Alos see


    2002
    JP Morgan – whose lawyers must be working overtime – is refuting any wrongdoing over credit default swaps it sold on Argentine sovereign debt to three hedge funds. But the bank failed to win immediate payment of $965 million from the 11 insurers it is suing for outstanding surety bonds.

    Christopher Jeffery Editor, March 2, 2002, RiskNews http://www.risknews.net

     


    2002
    Stanford University Law School Securities Class Action Clearinghouse
    --- http://securities.stanford.edu/
    Index for 1996-? --- http://securities.stanford.edu/companies.html

    Some of the many, many lawsuits settled by auditing firms can be found at http://www.trinity.edu/rjensen/Fraud001.htm
     

    2003
    The improper use of hedge accounting (contrary to FAS 133 rules) to amortize gains -- and thus smooth ragged ups and downs in quarterly earnings -- was Freddie's downfall. As a June 25 press release deadpanned: "Certain capital market transactions and accounting policies had been implemented with a view to their effect on earnings in the context of Freddie Mac's goal of achieving steady earnings growth." Translation: Steady earnings help Freddie convince investors and lenders that management has its eye on the ball. They also help ward off politicians who might point to volatility as a reason to tighten regulation or even break Freddie up. The company's quest for smooth earnings, plus its admitted lack of accounting expertise and weak management controls, proved to be a fateful combination. That became clear to PricewaterhouseCoopers auditors soon after they replaced longtime Freddie auditor Andersen LLC in 2002. The new audit team soon discovered suspicious hedge accounting involving Treasury securities.
    "Freddie Mac Attack Critics are calling for greater oversight -- or even a breakup," Business Week, July 7, 2003 --- http://www.businessweek.com/magazine/content/03_27/b3840057.htm

    2003
    "HUGE RISE IN USE OF DERIVATIVES WORRIES WATSA:  Fairfax chairman sees looming disaster,"
    by John Partridge, The Globe and Mail, (Canada), March 12, 2003, Page B10.

    The chairman of Fairfax Financial Holdings Ltd., like U.S. billionaire investor Warren Buffett, with whom he is sometimes compared, is warning that the "exponential increase" in the use of derivatives is a disaster in the making.

    "The total value of all unregulated derivatives is estimated to be US$128-trillion (not a typo)--roughly four times the underlying assets of the global economy," Prem Watsa says in an annual letter to shareholders of the Toronto property and casualty insurance holding company.

    "We have avoided companies that are highly exposed to derivatives.  It is another catastrophe waiting to happen!"

    Illustration of Continued SPE abuse and Derivatives Accounitng Fraud


    2003
    "The Accounting Cycle Biovail Exposed, Part I," by: J. Edward Ketz , AccountingWeb, April 2008 --- http://accounting.smartpros.com/x61528.xml

    On March 24 of this year, the Securities and Exchange Commission issued a litigation release against Biovail Corporation and several of its officers, including its former CEO Eugene Melnyk:

    This brings to a head, if not a conclusion, the spurious charges by Biovail that various hedge funds and analysts conspired to bring down the stock price of the firm. We know now that the firm's own managers decreased the value of the firm by their accounting frauds.

    The SEC's complaint claims that Biovail overstated its earnings from 2001 to 2003 through three schemes. First, Biovail removed $47 million of research and development expense from its income statement by transferring these costs to a special purpose entity. (The cynic in me is wondering how many SPEs are legitimate and how many are created primarily to deceive investors and creditors.) Second, Biovail created a fictitious bill-and-hold transaction, adding $8 million to income. Third, Biovail intentionally understated foreign exchange losses by $3.9 million. (The Ontario Securities Commission is also investigating these schemes.)

    Bob Jensen's reviews of Special Purpose Entities (SPEs), including those at Enron, are at http://www.trinity.edu/rjensen//theory/00overview/speOverview.htm


    2003
    In April 2003 the United States Financial Accounting Standards Board (FASB) issued the FAS 149 amendments to FAS 133. These amendments are much less technical and extensive relative to the FAS 138 amendments. FAS 149 deals with some issues of cash flows and normal purchase and normal sales (NPNS) exclusions from FAS 133. Intense lobbying pressure came from the electric power industry in the United States over what is commonly termed a “bookout” in that industry. Electric power is a somewhat unique commodity in that it cannot be stored up as inventory to cushion the shocks of somewhat unpredictable peaks in demand such as peaks caused by extreme weather temperatures. As a result power companies sign contracts in the power grid to increase capacity when needed. Typically these contracts are booked out (net settled) when added power is not needed from the grid. When the power industry approached the Derivatives Implementation Group (DIG) for FAS 133 guidance, the DIG concluded that since these contracts were normally net settled with bookouts, they had to be carried at fair value as derivative financial instruments. Intense lobbying later led to an amendment in FAS 138 to allow the power industry to treat bookouts as NPNS exclusions from FAS 133. This does not by default apply to other industries.


    2003
    Infectious Greed:  How Deceit and Risk Corrupted the Financial Markets
      (Henry Holt and Company, 2003, Page 381, ISBN 0-8050-7510-0)

    Thus, credit default swaps distorted global investment by leading parties to misprice credit risk. Borrowers who were not being monitored intended to take on greater risks, which meant that the banks making new loans to these borrowers would charge higher interest rates. As the cost of capital in the economy increased, companies would take on fewer projects at high cost, and economic growth would suffer. The International Monetary Fund concluded, "To the extent that regulatory arbitrage drives the growth of the market, banks may be encouraged to originate more credit business than they would have done otherwise and then transfer the risk to non- - or less-well-regulated entities . . . such as insurance companies and, to a lesser degree, hedge funds.

    . . .

    In his 2003 letter to Berkshire Hathaway shareholders, Warren Buffet waned of the dangers of credit default swaps, calling derivatives "time bombs" and "financial weapons of mass destruction." (Buffet had been burned by credit derivatives buried in portfolios held by General Re, a reinsurance company he had purchased.) While some market participants objected to Buffet's warning, calling it a "serious slur" and "bad judgment" Federal Reserve chairman Alan Greenspan took note.

    Greenspan had be resolutely pro-derivatives and anti-regulation. But on May 8, he appeared by satellite at a banking conference in Chicago and gave a very un-Greenspan-like speech. His remarks were lucid and hard-hitting criticism. He concluded that he was no longer "entirely sanguine with respect to the risks associated with derivatives" Reporters apparently had not idea what to do. Most newspapers ignored the speech; others covered it, but directly contradicted each other.


    2003
    "Actions by Bear Stearns, SchwabBroaden Mutual-Fund Scandal," by Randall Smith, The Wall Street Journal, November 17, 2003 --- http://online.wsj.com/article/0,,SB106881837539468700,00.html?mod=home_whats_news_us

    The mutual-fund trading scandals continue to spread, with Bear Stearns Cos., one of Wall Street's top trading operations, and Charles Schwab Corp., a familiar name among Main Street investors, the latest to discover possible improprieties.

    Bear Stearns, a big financial company that processes trades for dozens of other brokerage firms, quietly fired four brokers and two assistants last week in an action related to mutual-fund trading activity. Charles Schwab, which popularized mutual-fund investment through a pioneering "supermarket" of funds, disclosed it had found a "limited number of instances" of questionable trading as well as other issues at its U.S. Trust Co. unit.

    The involvement of Bear Stearns and Schwab underlines how big brokerage firms are now being drawn into the mutual-fund trading scandals, which once centered mainly on fund-management companies and a handful of aggressive hedge funds. Morgan Stanley, another big Wall Street firm, is expected to announce a $50 million settlement with the Securities and Exchange Commission related to the way the company sold mutual funds to individual investors, according to people familiar with the matter. In all, more than a dozen financial companies face allegations related to misconduct in selling or trading mutual funds.


    2003
    September 19, 2003 message from Risk Waters Group [RiskWaters@lb.bcentral.com

    Merrill Lynch has agreed sweeping reforms that will require all complex structured finance transactions effected by a third party with the bank to be authorised by a new Special and Structured Products Committee (SSPC). The development is the result of a deal struck with the US Department of Justice (DoJ) over charges of conspiracy with Enron. The bank has also agreed for the SSPC to be monitored for 18 months by an independent auditing firm. At the same time, a DoJ-selected attorney will review and oversee the work of the auditing firm. Merrill Lynch has declined to comment on any aspect of the deal. The co-operation agreement arose after three former Merrill executives were indicted on Wednesday by a federal grand jury on charges of conspiracy to commit wire fraud and falsify books and records. Merrill Lynch has accepted responsibility for the conduct of the three defendants - Daniel Bayly, former head of global investment banking; James Brown, head of Merrill's strategic asset lease and finance Group; and Robert Furst, the Enron relationship manager for Merrill Lynch in the investment banking division.


    2003
    T
    o say derivative accounting in America is in the sewer is an insult to sewage.
    Charles Munger (forwarded by Ganesh M. Pandit, DBA, CPA, CMA [profgmp@HOTMAIL.COM] )
    For more, click on http://money.cnn.com/2002/05/04/news/buffettr.reut/index.htm 

    Bob Jensen's threads on accounting for derivatives can be found at http://www.trinity.edu/rjensen/caseans/000index.htm

    Question:
    When does a hedge become a speculation?  

    Answer:
    There are essentially two answers.  Answer 1 is that a speculation arises when the hedge is not perfectly effective in covering that which is hedged such as the current value (fair alue hedge) of the hedged item or the hedged cash flow (cash flow hedge).  Testing for hedge ineffectiveness under FAS 133 and IAS 39 rules is very difficult for auditors.  Answer 2 is that a speculation arises when unsuspected credit risk arises from the settlements themselves such as when dealers who brokered hedge derivatives cannot back the defaults all parties contracted under the derivatives themselves.  Hedges may no longer be hedges!  Answer 2 is even more problematic in this particular down economy.

    There is a lot of complaining around the world about need for and technicalities of the U.S. FAS 133 and the international IAS 39 standards on Accounting for Financial Instruments Derivatives and Hedging Activities.  But recent scandals adding to the pile of enormous scandals in derivatives over the past two decades suggest an increased  need for more stringent rather than weakened standards for accounting for derivatives.  The main problem lies in valuation of these derivatives coupled with the possibility that what is a safe hedge is really a risky speculation.  A case in point is Newmont Mining Corporation's Yandal Project in Australia as reported by Steve Maich in "Newmont's Hedge Book Bites Back," on  Page IN1 of the March 4, 2003 edition of Canada's Financial Post --- http://www.financialpost.com/ 

    Even by the gold industry's relatively aggressive standards, Yandal's derivatives exposure is stunning.  The unit has 3.4 million ounces of gold committed through hedging contracts that had a market value of negative US$288-million at the end of 2002.

    That would be a problem for any major producer, but the situation is particularly dire for Yandal because the development's total proven and provable gold reserves are just 2.1 million ounces.  In other words, the project has, through its hedging contracts, committed to sell 60% more gold than it actually has in the ground.

    Making matters worse, the mine's counterparties can require Yandal to settle the contracts in cash, before they come due.  In all, about 2.8 million ounces are subject to these cash termination agreements by 2005, which could cost the company US$223.7-million at current market prices.

    With insufficient gold to meet its obligations, and just US$58-million in cash to make up the difference, bankruptcy may be the only option available to Yandal, analysts said.

    Comparing Yandal's reserves to its hedging liabilities "suggests that the Yandal assets may be worth more dead than alive," CIBC World Markets analyst Barry Cooper said in a report to clients.

    All this is raising even bigger questions about the impact that the Yandal situation might have on the industry's other major hedgers.  Companies such as Canada's Barrick Gold Corp. and Placer Dome Ltd. have lagged the sector's strong rally of the past year, largely because many investors and analysts distrust the companies' derivative portfolios.

    One thing that is not stressed hard enough in FAS 133 is the credit risk of the dealers themselves.  The FAS 133 standard and its international IAS 39 counterpart implicitly assume that when speculating or hedging with derivatives, the dealers who broker these contracts are highly credit worthy.  For example, in the case of interest rate swaps it is assumed that the dealer that brokers the swap will stand behind the swapping party and counterparty default risks.  There are now some doubts about this in the present weak economy.

    "Derivatives Market a 'Time Bomb':  Buffet," Financial Post, March 4, 2003, Page IN1 --- http://www.financialpost.com/ 
    Berkshire chairman warns of risks in shareholder letter --- http://www.berkshirehathaway.com/letters/letters.html 
    (The above link is not yet updated for the Year 2002 forthcoming annual Shareholder Letter.)

    Billionaire investor Warren Buffett calls derivative contracts "financial weapons of mass destruction, carrying dangers that while now latent are potentially lethal," according to excerpts from his forthcoming annual letter to Berkshire Hathaway Inc. shareholders.

    Mr. Buffett, whose company is now seeking to divest of derivatives business tied to its General Re purchase, also worries that substantial credit risk has become concentrated "in the hands of relatively few derivatives dealers."

    "Divided on Derivatives Greenspan:  Buffett at Odds on Risks of the Financial Instruments," by John M. Berry, The Washington Post, March 6, 2003, Page E01 --- http://www.washingtonpost.com/wp-dyn/articles/A48287-2003Mar5.html 

    The use of derivatives has grown exponentially in recent years. The total value of all unregulated derivatives is estimated to be $127 trillion -- up from $3 trillion 1990. J.P. Morgan Chase & Co. is the world's largest derivatives trader, with contracts on its books totaling more than $27 trillion. Most of those contracts are designed to offset each other, so the actual amount of bank capital at risk is supposed to be a small fraction of that amount.

    Previous efforts to increase federal oversight of the derivatives market have failed, including one during the Clinton administration when the industry, with support from Greenspan and other regulators, beat back an effort by Brooksley Born, the chief futures contracts' regulator. Sen. Dianne Feinstein (D-Calif.) has introduced a bill to regulate energy derivatives because of her belief that Enron used them to manipulate prices during the California energy crisis, but no immediate congressional action is expected.

    Randall Dodd, director of the Derivatives Study Center, a Washington think tank, said both Buffett and Greenspan are right -- unregulated derivatives are essential tools, but also potentially very risky. Dodd believes more oversight is needed to reduce that inherent risk.

    "It's a double-edged sword," he said. "Derivatives are extremely useful for risk management, but they also create a host of new risks that expose the entire economy to potential financial market disruptions."

    Buffett has no problem with simpler derivatives, such as futures contracts in commodities that are traded on organized exchanges, which are regulated. For instance, a farmer growing corn can protect himself against a drop in prices before he sells his crop by buying a futures contract that would pay off if the price fell. In essence, derivatives are used to spread the risk of loss to someone else who is willing to take it on -- at a price.

    Buffett's concern about more complex derivatives has increased since Berkshire Hathaway purchased General Re Corp., a reinsurance company, with a subsidiary that is a derivatives dealer. Buffett and his partner, Charles T. Munger, judged that business "to be too dangerous."

    Because many of the subsidiary's derivatives involve long-term commitments, "it will be a great many years before we are totally out of this operation," Buffett wrote in the letter, which was excerpted on the Fortune magazine Web site. The full text of the letter will be available on Berkshire Hathaway's Web site on Saturday. "In fact, the reinsurance and derivatives businesses are similar: Like Hell, both are easy to enter and almost impossible to exit."

    One derivatives expert said several of General Re's contracts probably involved credit risk swaps with lenders in which General Re had agreed to pay off a loan if a borrower -- perhaps a telecommunications company -- were to default. In testimony last year, Greenspan singled out the case of telecom companies, which had defaulted on a significant portion of about $1 trillion in loans. The defaults, the Fed chairman said, had strained financial markets, but because much of the risk had been "swapped" to others -- such as insurance companies, hedge funds and pension funds -- the defaults did not cause a wave of financial-institution bankruptcies.

    "Many people argue that derivatives reduce systemic problems, in that participants who can't bear certain risks are able to transfer them to stronger hands," Buffett acknowledged. "These people believe that derivatives act to stabilize the economy, facilitate trade and eliminate bumps for individual participants. And, on a micro level, what they say is often true. Indeed, at Berkshire, I sometimes engage in large-scale derivatives transactions in order to facilitate certain investment strategies."

    But then Buffett added: "The macro picture is dangerous and getting more so. Large amounts of risk, particularly credit risk, have become concentrated in the hands of relatively few derivatives dealers, who in addition trade extensively with one another. The troubles of one could quickly infect the others. On top of that, these dealers are owed huge amounts by nondealer counterparties," some of whom are linked in such a way that many of them could run into problems simultaneously and set off a cascade of defaults.


    2003

    U.S. Securities and Exchange Commission
    Washington, D.C.

    Litigation Release No. 18038 / March 17, 2003

    Accounting and Auditing Enforcement Release No. 1742 / March 17, 2003

    Securities and Exchange Commission v. Merrill Lynch & Co., Inc., Daniel H. Bayly, Thomas W. Davis, Robert S. Furst, Schuyler M. Tilney, Case No. H-03-0946 (Hoyt) (S.D. Tx)

    SEC Charges Merrill Lynch, Four Merrill Lynch Executives with Aiding and Abetting Enron Accounting Fraud

    Merrill Lynch Simultaneously Settles Charges for Permanent Anti-Fraud Injunction and Payment of $80 Million in Disgorgement, Penalties and Interest

    The Securities and Exchange Commission today charged Merrill Lynch & Co., Inc. and four of its former senior executives with aiding and abetting Enron Corp.'s securities fraud. The Commission's complaint, filed in U.S. District Court in Houston, alleges that Merrill Lynch and its former executives aided and abetted Enron Corp.'s earnings manipulation by engaging in two fraudulent year-end transactions in 1999. The transactions had the purpose and effect of overstating Enron's reported financial results. Specifically, Enron used these transactions to add approximately $60 million to its fourth quarter of 1999 income (improving net income from $199 million to $259 million or 33 percent) and to increase its full year 1999 earnings per share from $1.09 to $1.17.

    Simultaneous with the filing of this action, the Commission has agreed to accept Merrill Lynch's offer to settle this matter. Merrill Lynch, without admitting or denying the allegations in the complaint, has agreed to pay $80 million dollars in disgorgement, penalties and interest and has agreed to the entry of a permanent anti-fraud injunction prohibiting future violations of the federal securities laws. The Commission intends to have these funds paid into a court account pursuant to the Fair Fund provisions of Section 308(a) of the Sarbanes-Oxley Act of 2002 for ultimate distribution to victims of the fraud. The four former Merrill Lynch executives named in the complaint, Robert S. Furst, Schuyler M. Tilney, Daniel H. Bayly, and Thomas W. Davis, are contesting the matter.

    The Commission's complaint alleges that, in late December 1999, senior Enron executives approached Merrill Lynch with the two transactions it had designed. As alleged, the first transaction was an asset-parking arrangement whereby on December 29, 1999, Merrill Lynch bought an interest in certain Nigerian barges from Enron with an express understanding that Enron would arrange for the sale of this interest by Merrill Lynch within six months at a specified rate of return. In substance, this transaction was, at best, a bridge loan because the risks and rewards of ownership of the interest in the barges did not pass to Merrill Lynch.

    As further alleged in the complaint, Merrill Lynch and the named executives knew that Enron would record $28 million in revenue and $12 million in pre-tax income in connection with this transaction. The Commission alleges that Merrill Lynch and the named executives entered into this transaction solely to accommodate Enron, despite express concerns that Merrill Lynch could appear to be aiding and abetting Enron's earnings manipulation. In 2000, Enron arranged to take Merrill Lynch out of the barge deal on the agreed time frame at the agreed rate of return.

    In the second transaction, also closed in the last days of December 1999, Merrill Lynch and Enron entered into two energy options — one physical and one financial — that Merrill Lynch knew had the purpose and effect of inflating Enron's income by approximately $50 million. The complaint details that, at year-end 1999, the trading under these options was not scheduled to begin for approximately nine months. Before the transaction was closed, the complaint alleges, Enron told Merrill Lynch that, despite a nominal term of four years, it might want to unwind this transaction early.

    Merrill Lynch believed that the two trades were essentially a wash and knew that the transaction would have a significant impact on Enron's reported results, bonuses, and stock price. Merrill Lynch demanded a multi-million dollar fee for entering into this transaction; Enron ultimately agreed to pay Merrill Lynch a structured fee to be paid over four years with a net present value of $17 million. In 2000, Enron approached Merrill Lynch seeking to unwind the transaction before trading under the energy options was scheduled to begin. The deal was unwound in June 2000 after Merrill Lynch agreed to reduce its fee to $8.5 million to terminate the transaction.

    The complaint alleges that Merrill Lynch and the named executives aided and abetted Enron's violations of the anti-fraud, reporting, books and records, and internal controls provisions of the federal securities laws. For these violations, the Commission seeks in its complaint a permanent injunction, disgorgement, and civil penalties with respect to Merrill Lynch and, with respect to the individual defendants, permanent injunctions, civil penalties, and permanent officer and director bars.

    Simultaneous with the filing of the complaint, Merrill Lynch agreed to file a consent and final judgment settling the Commission's action against it. In the consent, Merrill Lynch has agreed, without admitting or denying the allegations of the complaint, to the entry of a final judgment permanently enjoining it from future violations of Sections 10(b), 13(a), 13(b)(2), and 13(b)(5) and of the Securities Exchange Act of 1934 and Rules 10b-5, 12b-20, 13a-1, 13a-13, and 13b2-1 thereunder.

    Merrill Lynch also has agreed to pay disgorgement, penalties and interest in the amount of $80 million. Specifically, Merrill Lynch will pay $37.5 million in disgorgement, $5 million in prejudgment interest, and a civil penalty of $37.5 million. As noted above, the Commission intends to have these funds paid into a court account pursuant to the Fair Fund provisions of Section 308(a) of the Sarbanes-Oxley Act of 2002 for ultimate distribution to victims of the fraud.

    In agreeing to resolve this matter on the terms described above, the Commission took into account certain affirmative conduct by Merrill Lynch. Merrill Lynch terminated Messrs. Davis and Tilney after they refused to testify before the staff and instead asserted their Fifth Amendment rights. In addition, Merrill Lynch brought the energy trade transaction to the staff's attention at a time when it believed the staff was unaware of its existence.


    2003
    The $1.4 billion settlement sounds like a big number, but the crooks are only giving back a small fraction of the take.

    "Wall Street Firms Settle Charges Over Research in $1.4 Billion Pact," by Randall Smith, Susanne Craig, and Deborah Solomon, The Wall Street Journal, April 29, 2003, Page C1

    In a pact that could change the face of Wall Street, 10 of the nation's largest securities firms agreed to pay a record $1.4 billion to settle government charges involving abuse of investors during the stock-market bubble of the late 1990s.

    The long-awaited settlement, which followed an intense investigation that brought together three national regulatory bodies and a dozen state securities authorities, centers on civil charges that the Wall Street firms routinely issued overly optimistic stock research to investors in order to curry favor with corporate clients and win their lucrative investment-banking business. The pact also settles charges that at least two big firms, Citigroup Inc.'s Citigroup Global Markets unit, formerly Salomon Smith Barney, and Credit Suisse Group's Credit Suisse First Boston, improperly doled out coveted shares in initial public offerings to corporate executives in a bid to win banking business from their companies.

    Regulators unveiled dozens of previously undisclosed examples of financial analysts tailoring their research reports and stock ratings to win investment-banking business. They added up to a scathing critique that scorched all the firms involved. The boss of one star analyst, Internet expert Mary Meeker of Morgan Stanley, praised her for being "highly involved" in the firm's investment-banking business. An analyst at the UBS Warburg unit of UBS AG explained she soft-pedaled concerns about a drug because its developer was "a very important client."

    "I am profoundly saddened -- and angry -- about the conduct that's alleged in our complaints," said William Donaldson, chairman of the Securities and Exchange Commission. "There is absolutely no place for it in our marketplace and it cannot be tolerated."

    The penalties included lifetime bans from the securities business for two former star analysts, Jack Grubman of Salomon and Henry Blodget of Merrill Lynch & Co., who were charged with issuing fraudulent research reports and agreed to pay penalties of $15 million and $4 million, respectively. Both the firms and the individuals consented to the charges without admitting or denying wrongdoing. But the regulators vowed to pursue cases against analysts and their supervisors as far up the chain of command as possible.

    Bowing to political pressure from Congress, the regulators, which also included the National Association of Securities Dealers, the New York Stock Exchange and state regulators led by New York's Eliot Spitzer, also won a promise by the firms not to seek insurance repayment or tax deductions for $487.5 million of the settlement payments.

    The agreement sets new rules that will force brokerage companies to make structural changes in the way they handle research. Analysts, for instance, will no longer be allowed to accompany investment bankers during sales pitches to clients. The pact also requires securities firms to have separate reporting and supervisory structures for their research and banking operations, and to tie analysts' compensation to the quality and accuracy of their research, rather than how much investment-banking fees they help generate.

    Moreover, stock research will be required to carry the equivalent of a "buyer beware" notice. Securities firms, regulators said, must include on the first page of research reports a note making clear that the reports are produced by firms that do investment-banking business with the companies they cover. This, the firms must acknowledge, may affect the objectivity of the firms' research.

    Continued in the article.

    THE REFORMS
     
    The main points of the settlement:

     
     A clear separation of stock research from investment banking
     
     "Independent" research for investors at no cost
     
     Better disclosure of stock rankings
     
     Ban of IPO "spinning"
     
     $1.4 billion payout, including a $387.5 million investor fund
     
     Penalties aren't tax deductible for the firms
     
    WHO ALLEGEDLY DID WHAT
     
    Issued fraudulent research reports
    CSFB
    Merrill Lynch
    Salomon Smith Barney
    Issued unfair research, or research not in good faith
    Bear Stearns
    CSFB
    Goldman Sachs
    Lehman Brothers
    Merrill Lynch
    Piper Jaffray
    Salomon Smith Barney
    UBS
    Received or made undisclosed payments for research
    UBS
    Piper Jaffray
    Bear Stearns
    Morgan Stanley
    J.P. Morgan
    Engaged in spinning of IPOs
    CSFB
    Salomon Smith Barney
    Source: Securities and Exchange Commission --- www.sec.gov
     

    2003
    Are you disgusted enough with mutual funds to raise a stink?  So far, savers don't seem nearly as outraged as they were about Enron--yet deceptive funds and sneaky "financial advisers" have swiped more money, from more people, than all the corporate scandals combined.  The House of Representatives just passed a reform bill, but in the Senate, the going looks tough.  Your legislators are scooping up money from the mutual-fund lobby, which hopes to head off any major change.  To counter the lobby, Congress needs angry protest calls from voters like you.
    Jane Bryant Quinn, "FIGHTING THE FUND CHEATS," by Jane Bryant Quinn, Newsweek Magazine, December 8, 2003, Page44.

    Illegal or unfair trading isn't hard for directors (or the SEC) to spot, says New York Attorney General Eliot Spitzer, who brought the first of these scandals to light.  They just have to compare their funds' total sales with total redemptions.  When the two are about the same, skimming might be going on.  I asked Lipper, a fund-tracking service, to list the larger funds where redemptions reached 90 to 110 percent of sales.  It found 229, some looking obviously churned.
    Jane Bryant Quinn
    --- http://www.trinity.edu/rjensen/fraud.htm#Cleland 


    2003
    Stanford University Law School Securities Class Action Clearinghouse
    --- http://securities.stanford.edu/
    Index for 1996-? --- http://securities.stanford.edu/companies.html

     Some of the many, many lawsuits settled by auditing firms can be found at http://www.trinity.edu/rjensen/Fraud001.htm
     


    2004
    $25 BILLION of Fannie Mae Derivative (Potential) Losses --- http://worldvisionportal.org/WVPforum/viewtopic.php?t=192 

    The Timeline of the Recent History of Fannie Mae Scandals 2002-2008 --- http://www.trinity.edu/rjensen/caseans/000index.htm#FannieMae
    "Fannie Mayhem: A History," The Wall Street Journal, July 14, 2008


    2004
    Federal regulators are investigating whether some commodity traders last month had advance knowledge that the first U.S. case of mad-cow disease was confirmed in Washington state.

    "U.S. Investigates Cattle Trades," by John R. Wilke, The Wall Street Journal, January 27, 2004 --- http://online.wsj.com/article/0,,SB107515641699512022,00.html?mod=home_whats_news_us 
    Jensen Comment
    Many of these trades entailed derivative contracts.


    2004
    "Cooking The Books Part II - US $71 Trillion Casino Banks," by Michael Edward, Rense.com, March 27. 2004 ---
    http://www.rense.com/general50/cooking2.htm

    Derivative holdings by U.S. banks increased nearly $4 TRILLION in just 3 months to now total over $71.1 TRILLION. JPMORGAN CHASE accounts for $3.1 TRILLION of this increase.

    That's $ 71,100,000,000,000.

    The first 7 banks listed below account for 96% of all commercial bank derivative holdings, with 90% of these derivatives in extremely risky OTC (Over the Counter) contracts.


    2004
    "When Bankers' Bets Go Bad
    With a load of derivatives to unwind, banks may face serious trouble from rising rates ," by Mara Der Hovanesian, Business Week, June 14, 2004, pp. 78-79 --- http://www.businessweek.com/@@y4MltmUQz2Pg7RMA/premium/content/04_24/b3887084_mz020.htm 

    Has your conservative commercial bank suddenly become a day trader placing big bets on interest rates? These days, the odds are it has. At the end of last year banks had a gross $71 trillion worth of derivatives on their books, based mostly on interest rates, according to the Office of the Comptroller of the Currency (OCC). That's double the amount of five years ago. Much of the activity is designed to protect the value of the mortgages they hold. But increasingly, banks are trading simply to make some money on the side.

    The tactic can be rewarding. National City Corp. (NCC ), a Cleveland bank, said it earned $295 million pretax from interest-rate swaps in the first quarter. Winston-Salem's BB&T Corp. (BBT ) began hedging its mortgage servicing business with derivatives last summer. It posted a $4 million loss in the first quarter, a tenth of what it would have been without the hedging. Meanwhile, the nation's largest thrift, Washington Mutual Inc. (WM ), also has been "opportunistic" in its buying and selling of mortgage securities, says bank analyst David A. Hendler of CreditSights Inc.: "It was trading Treasury and mortgage-backed securities and taking gains when it could."

    The gusher of easy money could be drying up. Earlier this year many banks arranged their portfolios to benefit from low interest rates, betting that those rates would stay down most of the year. So they were caught off guard when rates spiked from their March lows. Many were left holding low-yielding securities and were hit by losses on complex derivative contracts that take time to unwind. "They played the trading game for quite a while, and it worked," says Ron Papanek, market strategist for New York's RiskMetrics Group. "Now they're looking down the barrel of a Fed move." Adds Peter Nerby, a senior bank analyst at Moody's Investors Service (MCO ): "It's going to be a lot tougher for people to make money."

    Or worse. The runup in rates in 1994 wreaked havoc on banks' securities holdings. Banks were socked with losses totaling about $16 billion, according to the OCC. Big regional banks such as Chicago's Bank One Corp. (ONE ) and PNC Bank Corp. (PNC ) of Pittsburgh took sizable hits. Cleveland-based KeyCorp (KEY ) lost $865 million, mostly in interest-rate swaps, by the third quarter of that year.


    2004
    From Orange County to Enron and Beyond
    Whenever a huge financial scandal surfaces, more often than not Merrill Lynch pays up.
    Eliott Spitzer once said that his smoking gun could have shot Merrill completely out of the water if the economic consequences would not have been so enormous.  When will Merrill ever clean up its act?
    A jury has convicted four former Merrill Lynch executives and a former Enron finance executive for helping push through a sham deal to pad the energy company's earnings
    "5 Executives Convicted of Fraud in First Enron Trial," The New York Times,
    November 3, 2004 --- http://www.nytimes.com/aponline/business/03WIRE-ENRON.html


    2004
    Stanford University Law School Securities Class Action Clearinghouse
    --- http://securities.stanford.edu/
    Index for 1996-? --- http://securities.stanford.edu/companies.html

    Some of the many, many lawsuits settled by auditing firms can be found at http://www.trinity.edu/rjensen/Fraud001.htm
     

    2005
    "The Role of Derivatives in Corporate Finances: Are Firms Betting the Ranch?" Finance and Investment at Wharton, December 2005 --- http://knowledge.wharton.upenn.edu/article/1346.cfm

    2005
    Officials in Durham, N.C., hope that a financial transaction with a private New York firm will save the city millions of dollars on its municipal debt. But some say the deal -- an interest-rate swap with a formula that multiplies the city's potential savings as well as its potential losses -- may contain costly risk. "They're entering into a gamble where they believe they're going to win more money than they're going to lose," says Robert Whaley, professor of finance and a derivatives expert at Duke University in Durham. "It's just speculation."
    Karen Richardson, "Swapping Rates to Save on Debt ... Maybe:  Rice Financial Products Offers Cities, States Deal Rife With Benefits, Risks," The Wall Street Journal,  March 15, 2005; Page C3 --- http://online.wsj.com/article/0,,SB111083206224878924,00.html?mod=todays_us_money_and_investing 


    2005
    Kate Welling's interview with Frank Partnoy --- http://www.trinity.edu/rjensen/tidbits/2005/tidbits051112.htm
    Kate
    You paint a stark picture in your book: "Any appearance of control in today's financial markets is only an illusion, not a grounded reality.  Markets have come to the brink of collapse several times during the past decade...Today, the risk of system-wide collapse is greater than ever before..." And you hang much of the blame on the investment culture of the 1990s.  More specifically, runaway complexity--derivatives--the emergence of what I call imperial corporate managements, deregulation and outgunned cops.  I don't as much disagree as quibble that your perspective is too fore-shortened.  You look at league tables through the 1990s and say Wall Street's basic structure hasn't changed.  I'd contend, quite the `contrary, that the basic economics of the business--and therefore, inevitably, it's structure--have gone through a wrenching secular, or once-in-multiple-generations-type, transformation over the last 30-40 years; basically since the end of "The Go-Go Years" immortalized by "Adam Smith," precisely because of a confluence of dramatic social, regulatory, technological and economic changes.  Or because of unintended or unimagined consequences of those changes.  You don't really go back far enough in your book to capture the enormous shift in the Street's ownership structure and balance of power that flowed, for instance, from the end of fixed commission rates on May Day, 1970.  Or how that enslaved research to investment banking.  Or how the corporatization of the Street, traditionally dominated by private partnerships, loosened morals.  And on and on.

    Frank Partnoy
    I think that is very fair.  But I had to pick a starting point for the book and what I wanted to describe in Infectious Greed is more modest.  What you have described is a much more ambitious project, to describe the overall set of changes that have resulted in Wall Street's current predicament; to trace them back as far as is relevant to today.  My book is a much more modest attempt to figure out the extent to which financial innovation has changed the way Wall Street works.  To what extent can you run through the thought experiment of thinking about financial innovation as a virus?  So if if you trace that back, how far do you go?  I don't think you go back to the 1970s to run that experiment.  I might not have hit exactly the right point, it starting with Andy Krieger's currency options trading for Bankers Trust back in 1988, but innovation started to take off somewhere around that time.  Obviously, I can't explain everything in terms of the growth of derivatives and complex financial transactions and the changes in regulations that relate to them.  But my objective in writing the book was to say, "Hey, they can explain a lot."  These things--derivatives--are a way to tell a story that connects the dots.  What's happened in all the Wall Street and corporate scandals was not caused, simply, by a bunch of individuals acting like bad apples.  There is a way to understand how the last 15 years have happened through the lens of financial innovation and the increase in the complexity of financial instruments and the institutions that trade them, at the same time that markets were being excessively deregulated.

    Kate
    So it couldn't have happened, at least in the same ways, except against the backdrop of what started out being called the "Reagan Revolution?"

    Frank Partnoy
    That is right.  Although I don't focus so much on Reagan, the deregulatory culture clearly started in 1980.  But with respect to the financial markets, I think the key time is really a little bit later than that.  I think it is post-Drexel, too.  I would really focus more on the Levitt era.  I think a lot of problems have to do with the Clinton Administration taking a hands-off approach to Wall Street--certainly avoiding the use of criminal law to keep the Street in line.  You know, one of the big differences under Reagan was that people were put in jail for breaking securities laws.


    2005
    European Commission presented legislation in 2001 to require use of IASC Standards for all listed companies no later than 2005. Until this legislation passed IASC/IASB standards were voluntary in most nations and developed nations like the U.S., the U.K., Canada, Australia, France, Germany, etc. largely followed their own national standards.

    The most important element of requiring IASC/IASB standards (now more commonly called IFRS standards) was that these standards could take harder stands on more controversial issues like accounting for derivative financial instruments. Until then these international standards were mostly about motherhood and apple pie to encourage nations to voluntarily adopt them. The legal requirement in Europe set a precedent such that European nations could not opt out because they did not like certain standards like IAS 39 on accounting for derivative financial instruments and hedges.


    2005
    European Commissioner supports ‘roadmap’ developed by staff of US SEC towards the removal by 2008 of the requirement for companies to reconcile from IFRS to US GAAP when listing in the US. This means that IAS 39 can take the place of FAS 133 for foreign registrants of the Securities and Exchange Commission in the United States.

    A major factor in the SEC's decision to accept IFRS international standards for foreign registrants was the effort of the IASB to add substance to international standards on controversial issues like pensions, leases, hidden reserves, and derivative financial instruments.


    2005
    SEC Regulation NMS of 2005--- http://www.sec.gov/rules/final/34-51808.pdf

     The Securities and Exchange Commission ("Commission") is adopting rules under Regulation NMS and two amendments to the joint industry plans for disseminating market information. In addition to redesignating the national market system rules previously adopted under Section 11A of the Securities Exchange Act of 1934 ("Exchange Act"), Regulation NMS includes new substantive rules that are designed to modernize and strengthen the regulatory structure of the U.S. equity markets. First, the "Order Protection Rule" requires trading centers to establish, maintain, and enforce written policies and procedures reasonably designed to prevent the execution of trades at prices inferior to protected quotations displayed by other trading centers, subject to an applicable exception. To be protected, a quotation must be immediately and automatically accessible. Second, the "Access Rule" requires fair and non-discriminatory access to quotations, establishes a limit on access fees to harmonize the pricing of quotations across different trading centers, and requires each national securities exchange and national securities association to adopt, maintain, and enforce written rules that prohibit their members from engaging in a pattern or practice of displaying quotations that lock or cross automated quotations. Third, the "Sub-Penny Rule" prohibits market participants from accepting, ranking, or displaying orders, quotations, or indications of interest in a pricing

    increment smaller than a penny, except for orders, quotations, or indications of interest that are priced at less than $1.00 per share. Finally, the Commission is adopting amendments to the "Market Data Rules" that update the requirements for consolidating, distributing, and displaying market information, as well as amendments to the joint industry plans for disseminating market information that modify the formulas for allocating plan revenues ("Allocation Amendment") and broaden participation in plan governance ("Governance Amendment").


    2005
    Stanford University Law School Securities Class Action Clearinghouse
    --- http://securities.stanford.edu/
    Index for 1996-? --- http://securities.stanford.edu/companies.html

    Some of the many, many lawsuits settled by auditing firms can be found at http://www.trinity.edu/rjensen/Fraud001.htm
     

    2006
    Fannie Mae Sues KPMG The mortgage lending company Fannie Mae filed suit on Tuesday against its former auditor KPMG, accusing the firm of negligence and breach of contract for its part in the flawed accounting that led to a $6.3 billion restatement of earnings. Fannie Mae states in its complaint that KPMG applied more than 30 flawed principles and cost it more than $2 billion in damages. Fannie Mae fired the accounting firm in mid-December 2004, just a week after the Securities and Exchange Commission ordered the company to restate more than two years of flawed earnings. A KPMG spokesman,
    Tom Fitzgerald, said the company planned to “pursue our own claims against Fannie Mae.” "Fannie Mae Sues KPMG," The New York Times, December 13, 2006 --- http://www.nytimes.com/2006/12/13/business/13kpmg.html?_r=1&oref=slogin 
    For more on Fannie Mae's woes go to http://www.trinity.edu/rjensen/caseans/000index.htm#FannieMae

    "The Potential Crisis at Fannie Mae," Comstock Funds, August 11, 2005 --- http://snipurl.com/Fannie133 

    We have no proprietary information about Fannie Mae, but what is publicly known is scary enough. As you may recall, last December the SEC required Fannie to restate prior financial statements while the Office of Federal Oversight (OFHEO) accused the company of widespread accounting regularities that resulted in false and misleading statements. Significantly, the questionable practices included the way Fannie accounted for their huge amount of derivatives. On Tuesday, a company press release gave some alarming hints on how extensive the problem may be.

    The press release stated that in order to accomplish the restatements, “we have to obtain and validate market values for a large volume of transactions including all of our derivatives, commitments and securities at multiple points in time over the restatement period. To illustrate the breadth of this undertaking, we estimate we will need to record over one million lines of journal entries, determine hundreds of thousands of commitment prices and securities values, and verify some 20,000 derivative prices …”

    “…This year we expect that over 30 percent of our employees will spend over half their time on it, and many more are involved. In addition we are bringing some 1,500 consultants on board by year’s end to help with the restatement…Altogether, we project devoting six to eight million labor hours to the restatement. We are also investing over $100 million in technology projects to enhance or create new systems related to accounting and reporting…we do not believe the restatement will be completed until sometime during the second half of 2006…”

    "Fannie Mae Faces Work After Restatement," by Marcy Gordon, SmartPros, December 8, 2006 --- http://accounting.smartpros.com/x55766.xml

    Mortgage giant Fannie Mae has taken a significant stride in its march out of an accounting scandal by completing a restatement of past earnings but still faces tough work to make its financial reporting current. The restatement for 2001 through June 30, 2004, made public on Wednesday, wiped out $6.3 billion in profit for the government-sponsored company, which finances one of every five home loans in the United States. But it was well below Fannie Mae's earlier estimate of $10.8 billion. Ordered by the government two years ago, the massive reworking of its accounting has cost the company some $1 billion this year to carry out.

    "Too Political to Fail," The Wall Street Journal, April 21, 2008; Page A16 --- Click Here

    When Fannie went two years without filing financial reports, the New York Stock Exchange passed the "Fannie rule" to avoid having to delist the stock. And now the three top executives during the height of Fannie's accounting fraud have walked away with only a token acknowledgement of "managerial" responsibility for a $10 billion scandal. Recall that their huge bonuses depended on reported profits that were later determined to be fanciful. Recall, too, that Mr. Raines, other Fannie executives and their Wall Street retinue derided those of us who wrote critically about their derivatives accounting before it all blew up.

    The Timeline of the Recent History of Fannie Mae Scandals 2002-2008 --- http://www.trinity.edu/rjensen/caseans/000index.htm#FannieMae
    "Fannie Mayhem: A History," The Wall Street Journal, July 14, 2008


    2006
    In February 2006 the United States Financial Accounting Standards Board (FASB) issued the FAS 155 that amends FAS 133.

    This Statement amends FASB Statements No. 133, Accounting for Derivative Instruments and Hedging Activities, and No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities. This Statement resolves issues addressed in Statement 133 Implementation Issue No. D1, “Application of Statement 133 to Beneficial Interests in Securitized Financial Assets.”

    This Statement:

    a. Permits fair value remeasurement for any hybrid financial instrument that contains an embedded derivative that otherwise would require bifurcation

    b. Clarifies which interest-only strips and principal-only strips are not subject to the requirements of Statement 133

    c. Establishes a requirement to evaluate interests in securitized financial assets to identify interests that are freestanding derivatives or that are hybrid financialinstruments that contain an embedded derivative requiring bifurcation

    d. Clarifies that concentrations of credit risk in the form of subordination are notembedded derivatives

    e. Amends Statement 140 to eliminate the prohibition on a qualifying special purpose entity from holding a derivative financial instrument that pert


    2006
    In September 2006 the United States Financial Accounting Standards Board (FASB) issued the FAS 157 that affects FAS 133. This standard applies to all financial instruments, including derivative financial instruments that are carried at fair value rather than historical cost.

    The changes to current practice resulting from the application of this Statement relate to the definition of fair value, the methods used to measure fair value, and the expanded disclosures about fair value measurements. The definition of fair value retains the exchange price notion in earlier definitions of fair value. This Statement clarifies that the exchange price is the price in an orderly transaction between market participants to sell the asset or transfer the liability in the market in which the reporting entity would transact for the asset or liability, that is, the principal or most advantageous market for the asset or liability. The transaction to sell the asset or transfer the liability is a hypothetical transaction at the measurement date, considered from the perspective of a market participant that holds the asset or owes the liability. Therefore, the definition focuses on the price that would be received to sell the asset or paid to transfer the liability (an exit price), not the price that would be paid to acquire the asset or received to assume the liability (an entry price). This Statement emphasizes that fair value is a market-based measurement, not an entity-specific measurement. Therefore, a fair value measurement should be determined based on the assumptions that market participants would use in pricing the asset or liability. As a basis for considering market participant assumptions in fair value measurements, this Statement establishes a fair value hierarchy that distinguishes between (1) market participant assumptions developed based on market data obtained from sources independent of the reporting entity (observable inputs) and (2) the reporting entity’s own assumptions about market participant assumptions developed based on the best information available in the circumstances (unobservable inputs). The notion of unobservable inputs is intended to allow for situations in which there is little, if any, market activity for the asset or liability at the measurement date. In those situations, the reporting entity need not undertake all possible efforts to obtain information about market participant assumptions. However, the reporting entity must not ignore information about market participant assumptions that is reasonably available without undue cost and effort.

    This Statement clarifies that market participant assumptions include assumptions about risk, for example, the risk inherent in a particular valuation technique used to measure fair value (such as a pricing model) and/or the risk inherent in the inputs to the valuation technique. A fair value measurement should include an adjustment for risk if market participants would include one in pricing the related asset or liability, even if the adjustment is difficult to determine. Therefore, a measurement (for example, a “mark-to-model” measurement) that does not include an adjustment for risk would not represent a fair value measurement if market participants would include one in pricing the related asset or liability. This Statement clarifies that market participant assumptions.

    Bob Jensen's threads on fair value accounting are at http://www.trinity.edu/rjensen/Theory01.htm#FairValue


    2006
    In spite of FAS 133 and IAS 39, shareholders and creditors are still left in the dark about huge risks companies may be taking in their derivative financial instruments contracts.

    "The Role of Derivatives in Corporate Finances: Are Firms Betting the Ranch?" Finance and Investment at Wharton, January 2006 --- http://knowledge.wharton.upenn.edu/article/1346.cfm

    Many American corporations use derivatives conservatively, to offset risks from fluctuating currency and interest rates. But over the years, companies such as Procter & Gamble and Gibson Greetings have run into serious financial trouble using derivatives in a more dangerous fashion -- to speculate.

    Is high-risk behavior common? Are shareholders in for ugly surprises if executives' derivatives bets go sour?

    That has long been nearly impossible to determine, says Wharton finance professor Christopher C. Geczy. "It's not well disclosed in the financial [statements]. It could be widespread, but it's hard to say."

    ...

    To get a better picture of derivatives' role in corporate finances, Geczy, Wharton accounting professor Catherine Schrand and their co-author, Bernadette A. Minton of Ohio State University, re-examined confidential responses collected in an earlier Wharton study that focused on 341 corporate respondents, 186 of which used derivatives. The companies studied were not concentrated in any one industry, but were part of a broad sample of U.S. public, non-financial firms. The researchers report their findings in a paper entitled, "Taking a View: Corporate Speculation, Governance and Compensation."

    "We found that there are corporations out there, some of them very large, which have speculated, or are speculating," Geczy says. Companies reporting that they frequently "actively take positions" in currency or interest-rate derivatives on the basis of likely market movements were defined as speculators. The researchers then looked at the nature of those companies. They concluded that companies typically speculate in hopes of adding to profits, but not to "bet the ranch" to get out of financial difficulties or to hit it big. Executives who conduct the speculation typically are not renegades but instead are encouraged to do so by their superiors and board. Furthermore, firms that engage in speculation generally have oversight and monitoring procedures to prevent abuse. Finally, executives' compensation was often tied in some way to their success in derivatives speculation.

    "The main findings are that firms take positions based on a view [of market conditions] when they believe they have an information advantage to predict rates, which is consistent with a profit-making motive for speculation," the researchers write.

    Derivatives are contracts whose values are tied to price changes of underlying securities. A typical currency derivative gives its owner the right or obligation to buy or sell a block of dollars, yen or other currency over a given period at a set exchange rate. Interest-rate derivatives are like insurance policies that pay off if rates move up or down a specified amount during the time covered.

    In one important use, derivatives can neutralize risks. An American company that must exchange dollars for yen to buy goods from Japan could use a currency derivative to make up the difference if the dollar falls and Japanese goods become more expensive. Essentially, the contract would allow the company to lock in today's exchange rate for a given period. The American company would lose money on the derivative contract if the dollar got stronger instead of weaker, but that would be offset by the lower cost of Japanese goods as dollars were exchanged for yen.

    A company could, however, use the same currency contract to speculate, by simply buying a contract in hopes it becomes more valuable as exchange rates change. Since the change in the contract's value would not be counterbalanced by a gain or loss in the purchase of Japanese goods, the company would suffer a net loss if the dollar strengthened and the contract loses value. This is speculation.

    In the 1990s, Procter & Gamble lost $157 million in a currency bet involving dollars and German marks, Gibson Greetings lost $20 million and Long-Term Capital Management, a hedge fund, lost $4 billion with currency and interest-rate derivatives.

    "Shooting for the Moon"

    Over the years, various theories have attempted to explain why firms would speculate with derivatives. One theory suggests it is practiced at troubled firms "betting the ranch" to recover. But Geczy and his colleagues concluded this is unlikely, as the speculating firms tended to have access to low-cost outside financing, which made betting the ranch unnecessary.

    In most cases, firms that speculate are using types of derivatives they have gained experience with through safer hedging strategies. Those that speculate with currency derivatives, for instance, typically operate in international markets. As the authors write: Companies that speculate with foreign currency derivatives "have a greater percentage of operating revenues and costs denominated in foreign currency relative to firms that never or sometimes actively take positions."

    Executives in charge of derivatives speculation tend to feel they have some unique insight into currency and interest-rate markets, even though their firm's main business may be entirely different, Geczy says. "They really believe they can make money. They feel like they can identify opportunities and/or trade with the advantage of low costs of leverage."

    Another theory is that executives use derivatives to "shoot for the moon" -- trying to push up the company's earnings to boost the stock price and thus the value of their own holdings. But according to Geczy, the goal appears to be more modest -- just to make some extra profit when they think the opportunity arises. "On average, they do not appear to be trying to make the firm really risky to make big payoffs."

    At the same time, says Geczy, "just because speculating firm managers do not appear to be shooting for the moon, so to speak, doesn't mean that there aren't dangers or that speculating firms cannot suffer large losses. What makes our research interesting is that these managers can, in fact, suffer large losses even if speculation is rational and profit-oriented."

    Generally, firms that speculate have structures that give executives significant authority and freedom. They may be well-insulated from shareholder pressure by poison-pill anti-takeover defenses, for example. As Geczy notes, "The companies that speculate seem to be ones where shareholders don't have as much power. It's basically stronger managers... stronger, confident management that thinks it can make money. However, this in no way means they are successful."

    As to whether there is more speculation going on now than in years past, "this is quite hard to say," notes Geczy. "We actually did a follow-up survey of respondents from the first survey and found that some firms moved from speculating to not speculating at all and, in fact, remarked that they didn't feel speculation added much value net of its risk. Others went from not speculating to speculating with the expectation of making a profit. So we see transitions in both directions."

    The original survey did not ask companies to report how much they earned or lost through derivatives speculation. Geczy and his colleges conducted follow-up interviews with some of the companies' executives but could not determine how successful the speculation was. "It's been fairly hard to track down whether they actually do make money," he says.

    But Geczy questions whether these executives, who typically speculate as a sideline to their main duties, can effectively compete with professionals who do it full-time. "It's hard to believe, frankly, that corporate treasurers know more than the financial markets about what foreign currency or interest rates are going to do," he said, adding, "We haven't been able to identify reliably positive results of using a perceived information-advantage" enjoyed by executives who speculate.

    What is clear, however, is that shareholders are generally in the dark about derivatives speculation. "An important aspect of this study is that we are able to assess whether investors, using publicly available data, could identify the firms that admit to speculation in a confidential survey," Geczy and his colleagues write. "The answer is that they could not."

    Continued in article


    2006
    A federal judge in Houston gave two former Merrill Lynch & Co. officials substantially shorter prison sentences than the government was seeking in a high-profile case that grew out of the Enron Corp. scandal. In a separate decision yesterday, another Houston federal judge said that bank-fraud charges against Enron former chairman Kenneth Lay would be tried next year, immediately following the conspiracy trial against Mr. Lay, which is set for January. Judge Sim Lake had previously separated the bank-fraud charges from the conspiracy case against Mr. Lay and his co-defendants, Enron former president Jeffrey Skilling and former chief accounting officer Richard Causey. The government had been seeking to try Mr. Lay on the bank-fraud charges within about the next two months . . . Judge Ewing Werlein, Jr. sentenced former Merrill investment banking chief Daniel Bayly to 30 months in federal prison and James Brown, who headed the brokerage giant's structured-finance group, to a 46-month term. The federal probation office, with backing from Justice Department prosecutors, had recommended sentences for Messrs. Bayly and Brown of about 15 and 33 years, respectively. Mr. Brown had been convicted on more counts than Mr. Bayly.

    John Emshwiller and Kara Scannell, "Merrill Ex-Officials' Sentences Fall Short of Recommendation," The Wall Street Journal, April 22, 2005, Page C3 ---
    http://online.wsj.com/article/0,,SB111410393680013424,00.html?mod=todays_us_money_and_investing
    Jensen Comment:  I double dare you to go to the top of this document and search for every instance of "Merrill" --- http://www.trinity.edu/rjensen/FraudCongress.htm

    Update on October 2007

    Then how come Merrill Lynch is on the verge of escaping the wrath of investors because of its involvement in some of Enron's corporate and accounting frauds? The Securities and Exchange Commission lays out the facts in various documents such as Litigation Release No. 20159 and Accounting and Auditing Enforcement Release No. 2619, and in the related Complaint in the U.S. District Court.
    "The Accounting Cycle:  The Merrill Lynch-Enron-Government Conspiracy," by: J. Edward Ketz, SmartPros, October 2007 --- http://accounting.smartpros.com/x59129.xml 

    In a 2004 trial, a jury found these four Merrill executives guilty of participating in a fraudulent scheme. The former Merrill managers appealed the verdicts, and amazingly the Fifth Circuit tossed them out. The appellate court held that those bankers provided "honest services" and that they did not personally profit from the deal.

    That argument assumes that getaway drivers supply honest services to bank robbers; after all, an oral agreement to repurchase the investment at 22 percent return is a strong signal that something is amiss with the transaction. The argument also shows a lack of understanding how managers profit in the real world. Investment bankers advance their careers by bringing in business that generates income for the bank; Merrill Lynch's executives did that with the Enron barge transaction, thereby promoting their careers, their promotions, and their salaries and bonuses, even if in an indirect fashion.


    2006
    How Bear Stearns Got Greener

    The strong earnings increase was also clouded by details of long-expected regulatory charges unveiled yesterday showing how three separate Bear units aided improper mutual-fund trading -- in some cases intentionally and despite thousands of complaints from the funds. Bear settled the charges by the Securities and Exchange Commission and the New York Stock Exchange, without admitting or denying wrongdoing, by agreeing to pay $250 million -- including $160 million in disgorgement of gains and a $90 million fine.
    Randall Smith and Tom Lauricella, "Bear Stearns to Pay $250 Million Fine; Net Rises 36%," The Wall Street Journal, March 17, 2006; Page C3 ---
    http://online.wsj.com/article/SB114210497174995838.html?mod=todays_us_money_and_investing

     

    2006
    Stanford University Law School Securities Class Action Clearinghouse
    --- http://securities.stanford.edu/
    Index for 1996-? --- http://securities.stanford.edu/companies.html

    Some of the many, many lawsuits settled by auditing firms can be found at http://www.trinity.edu/rjensen/Fraud001.htm
     

    2007
    In February 2007 the United States Financial Accounting Standards Board (FASB) issued the FAS 159 that affects FAS 133. FAS 159 provides an option to carry virtually all (with some isolated exceptions) financial instruments at fair value instead of historical cost, but the choice is optional. If some financial instruments that are hedged items were previously carried at historical cost, then electing to change the accounting to fair value under FAS 159 is likely to affect how the hedging contract is accounted for under FAS 133 rules. For example, if a company hedges a bond normally carried at amortized historical cost, changes in the fair value of an interest rate swap entails changing resetting the interest rate swap to fair value on every swap date with the offset going to Other Comprehensive Income (OCI) rather than current earnings. If the company changes the hedged item (bond) accounting to fair value under FAS 159 with changes in value going to current earnings, changes in fair value of the hedging contract (the swap) are now offset with changes to current earnings rather than OCI.

    2007
    Insider Trading at Bear Stearns

    A former broker at Bear Stearns, Ken Okada, is expected to plead guilty in a wide-ranging insider-trading case, becoming the ninth person to admit wrongdoing in a scheme that also involved employees at UBS and Morgan Stanley. An assistant United States attorney, Andrew Fish, revealed the expectation in a letter to a federal judge presiding over a related case brought by the Securities and Exchange Commission. The letter was entered into court records yesterday. Mr. Okada is one of 13 people charged by federal prosecutors in Manhattan in March.
    The New York Times, November 15, 2007 --- http://www.nytimes.com/2007/11/15/business/15insider.html?ref=business

     


    2007
    Lawyers Like the Subprime Litigation Cash Cow

    "The finger of suspicion," The Economist, December 19, 2007 --- http://www.economist.com/finance/displaystory.cfm?story_id=10337884

    FINANCIAL firms have already been drenched by mortgage-related losses. Now a wave of litigation threatens to assail them. According to RiskMetrics, a consulting firm, between August and October federal securities class-action lawsuits were filed in America at an annualised pace of around 270—more than double last year's total and well above the historical average. At this rate, claims could easily exceed those of the dotcom bust and options-backdating scandal combined.

    At most risk are banks that peddled mortgages or mortgage-backed securities. Investors have handed several writs to Citigroup and Merrill Lynch. Bear Stearns has received dozens over the collapse of two leveraged hedge funds. A typical complaint accuses it of failing to make adequate reserves or to explain the risks of its subprime investments, and of dubious related-party transactions with the funds. Several firms, including E*Trade, a discount broker with a banking arm sitting on a radioactive pile of mortgage debt, are being sued for allegedly failing to disclose problems as they became apparent to managers.

    But one thing that sets the subprime litigation wave apart from that of the 2001-03 bear market is its breadth. After the collapses of Enron and WorldCom, lawsuits were targeted at a fairly narrow range of parties: bust internet firms, their accountants and some banks. This time, investors are aiming not only at mortgage lenders, brokers and investment banks but also insurers (American International Group), bond funds (State Street, Morgan Keegan), rating agencies (Moody's and Standard & Poor's) and homebuilders (Beazer Homes, Toll Brothers et al).

    Borrowers, too, are suing both their lenders and the Wall Street firms that wrapped up their loans. Several groups of employees and pension-fund participants have filed so-called ERISA/401(k) suits against their own firms. Local councils in Australia are threatening to sue a subsidiary of Lehman Brothers over the sale of collateralised-debt obligations (CDOs), the Financial Times has reported. Lenders are even turning on each other; Deutsche Bank has filed large numbers of lawsuits against mortgage firms, claiming they owe money for failing to buy back loans that soured within months of being made.

    “It seems that everyone is suing everyone,” says Adam Savett of RiskMetrics' securities-litigation group. “It surely can't be long before we get the legal equivalent of man bites dog, where a lender sues its borrowers for some breach of contract.”

    Continued in article


    2007
    Stanford University Law School Securities Class Action Clearinghouse
    --- http://securities.stanford.edu/
    Index for 1996-? --- http://securities.stanford.edu/companies.html
     

    Some of the many, many lawsuits settled by auditing firms can be found at http://www.trinity.edu/rjensen/Fraud001.htm
     

    2008

    Greenspan's Disastrous Agency Problem
    In political science and economics, the principal-agent problem or agency dilemma treats the difficulties that arise under conditions of incomplete and asymmetric information when a principal hires an agent. Various mechanisms may be used to try to align the interests of the agent with those of the principal, such as piece rates/commissions, profit sharing, efficiency wages, performance measurement (including financial statements), the agent posting a bond, or fear of firing. The principal-agent problem is found in most employer/employee relationships, for example, when stockholders hire top executives of corporations. Numerous studies in political science have noted the problems inherent in the delegation of legislative authority to bureaucratic agencies. The implementation of legislation (such as laws and executive directives) is open to bureaucratic interpretation, creating opportunities and incentives for the bureaucrat-as-agent to deviate from the intentions or preferences of the legislators. Variance in the intensity of legislative oversight also serves to increase principal-agent problems in implementing legislative preferences.

    Wikipedia --- http://en.wikipedia.org/wiki/Agency_theory

     

    Not only have individual financial institutions become less vulnerable to shocks from underlying risk factors, but also the financial system as a whole has become more resilient.
    Alan Greenspan in 2004 as quoted by Peter S. Goodman, Taking a Good Look at the Greenspan Legacy," The New York Times, October 8, 2008 --- http://www.nytimes.com/2008/10/09/business/economy/09greenspan.html?em

    The problem is not that the contracts failed, he says. Rather, the people using them got greedy. A lack of integrity spawned the crisis, he argued in a speech a week ago at Georgetown University, intimating that those peddling derivatives were not as reliable as “the pharmacist who fills the prescription ordered by our physician.”

    But others hold a starkly different view of how global markets unwound, and the role that Mr. Greenspan played in setting up this unrest.

    “Clearly, derivatives are a centerpiece of the crisis, and he was the leading proponent of the deregulation of derivatives,” said Frank Partnoy, a law professor at the University of San Diego and an expert on financial regulation.

    The derivatives market is $531 trillion, up from $106 trillion in 2002 and a relative pittance just two decades ago. Theoretically intended to limit risk and ward off financial problems, the contracts instead have stoked uncertainty and actually spread risk amid doubts about how companies value them.

    If Mr. Greenspan had acted differently during his tenure as Federal Reserve chairman from 1987 to 2006, many economists say, the current crisis might have been averted or muted.

    Over the years, Mr. Greenspan helped enable an ambitious American experiment in letting market forces run free. Now, the nation is confronting the consequences.

    Derivatives were created to soften — or in the argot of Wall Street, “hedge” — investment losses. For example, some of the contracts protect debt holders against losses on mortgage securities. (Their name comes from the fact that their value “derives” from underlying assets like stocks, bonds and commodities.) Many individuals own a common derivative: the insurance contract on their homes.

    On a grander scale, such contracts allow financial services firms and corporations to take more complex risks that they might otherwise avoid — for example, issuing more mortgages or corporate debt. And the contracts can be traded, further limiting risk but also increasing the number of parties exposed if problems occur.

    Throughout the 1990s, some argued that derivatives had become so vast, intertwined and inscrutable that they required federal oversight to protect the financial system. In meetings with federal officials, celebrated appearances on Capitol Hill and heavily attended speeches, Mr. Greenspan banked on the good will of Wall Street to self-regulate as he fended off restrictions.

    Ever since housing began to collapse, Mr. Greenspan’s record has been up for revision. Economists from across the ideological spectrum have criticized his decision to let the nation’s real estate market continue to boom with cheap credit, courtesy of low interest rates, rather than snuffing out price increases with higher rates. Others have criticized Mr. Greenspan for not disciplining institutions that lent indiscriminately.

    But whatever history ends up saying about those decisions, Mr. Greenspan’s legacy may ultimately rest on a more deeply embedded and much less scrutinized phenomenon: the spectacular boom and calamitous bust in derivatives trading.

    Bob Jensen's timeline of derivatives scandals and the evolution of accounting standards for accounting for derivatives financial instruments can be found at http://www.trinity.edu/rjensen/FraudCongress.htm#DerivativesFrauds

    "‘I made a mistake,’ admits Greenspan," by Alan Beattie and James Politi, Financial Times, October 23, 2008 ---
    http://www.ft.com/cms/s/0/aee9e3a2-a11f-11dd-82fd-000077b07658.html?nclick_check=1

    “I made a mistake in presuming that the self-interest of organisations, specifically banks and others, was such that they were best capable of protecting their own shareholders,” he said.

    In the second of two days of tense hearings on Capitol Hill, Henry Waxman, chairman of the House of Representatives, clashed with current and former regulators and with Republicans on his own committee over blame for the financial crisis.

    Mr Waxman said Mr Greenspan’s Federal Reserve – along with the Securities and Exchange Commission and the US Treasury – had propagated “the prevailing attitude in Washington... that the market always knows best.”

    Mr Waxman blamed the Fed for failing to curb aggressive lending practices, the SEC for allowing credit rating agencies to operate under lax standards and the Treasury for opposing “responsible oversight” of financial derivatives.

    Christopher Cox, chairman of the Securities and Exchange Commission, defended himself, saying that virtually no one had foreseen the meltdown of the mortgage market, or the inadequacy of banking capital standards in preventing the collapse of institutions such as Bear Stearns.

    Mr Waxman accused the SEC chairman of being wise after the event. “Mr Cox has come in with a long list of regulations he wants... But the reality is, Mr Cox, you weren’t doing that beforehand.”

    Mr Cox blamed the fact that congressional responsibility was divided between the banking and financial services committees, which regulate banking, insurance and securities, and the agriculture committees, which regulate futures.

    “This jurisdictional split threatens to for ever stand in the way of rationalising the regulation of these products and markets,” he said.

    Mr Greenspan accepted that the crisis had “found a flaw” in his thinking but said that the kind of heavy regulation that could have prevented the crisis would have damaged US economic growth. He described the past two decades as a “period of euphoria” that encouraged participants in the financial markets to misprice securities.

    He had wrongly assumed that lending institutions would carry out proper surveillance of their counterparties, he said. “I had been going for 40 years with considerable evidence that it was working very well”.

    Continued in the article

    Jensen Comment
    In other words, he assumed the agency theory model that corporate employees, as agents of their owners and creditors, would act hand and hand in the best interest for themselves and their investors. But agency theory has a flaw in that it does not understand Peter Pan.

    Peter Pan, the manager of Countrywide Financial on Main Street, thought he had little to lose by selling a fraudulent mortgage to Wall Street. Foreclosures would be Wall Street’s problems and not his local bank’s problems. And he got his nice little commission on the sale of the Emma Nobody’s mortgage for $180,000 on a house worth less than $100,000 in foreclosure. And foreclosure was almost certain in Emma’s case, because she only makes $12,000 waitressing at the Country Café. So what if Peter Pan fudged her income a mite in the loan application along with the fudged home appraisal value? Let Wall Street or Fat Fannie or Foolish Freddie worry about Emma after closing the pre-approved mortgage sale deal. The ultimate loss, so thinks Peter Pan, will be spread over millions of wealthy shareholders of Wall Street investment banks. Peter Pan is more concerned with his own conventional mortgage on his precious house just two blocks south of Main Street. This is what happens when risk is spread even farther than Tinkerbell can fly!
    Also see how corporate executives cooked the books --- http://www.trinity.edu/rjensen/theory01.htm#Manipulation

    The Saturday Night Live Skit on the Bailout --- http://patdollard.com/2008/10/it-is-here-the-banned-snl-skit-cannot-hide-from-louie/ 

     

    Bankers (Men in Black) bet with their bank's capital, not their own. If the bet goes right, they get a huge bonus; if it misfires, that's the shareholders' problem.
    Sebastian Mallaby. Council on Foreign Relations, as quoted by Avital Louria Hahn, "Missing:  How Poor Risk-Management Techniques Contributed to the Subprime Mess," CFO Magazine, March 2008, Page 53 --- http://www.cfo.com/article.cfm/10755469/c_10788146?f=magazine_featured
    Jensen Comment
    Now that the Government is going to bail out these speculators with taxpayer funds makes it all the worse. I received an email message claiming that i
    f you had purchased $1,000 of AIG stock one year ago, you would have $42 left;  with Lehman, you would have $6.60 left; with Fannie or Freddie, you would have less than $5 left. But if you had purchased $1,000 worth of beer one year ago, drank all of the beer, then turned in the cans for the aluminum recycling REFUND, you would have had $214. Based on the above, the best current investment advice is to drink heavily and recycle. It's called the 401-Keg. Why let others gamble your money away when you can piss it away on your own?

     

    Peter, Paul, and Barney: An Essay on 2008 U.S. Government Bailouts of Private Companies ---
    http://www.trinity.edu/rjensen/2008Bailout.htm

    Bob Jensen's threads on earnings management and creative accounting to cook the books ---
    http://www.trinity.edu/rjensen/theory01.htm#Manipulation

     


    2008

    "Fed's rescue halted a derivatives Chernobyl," London Telegraph, March 24, 2008 ---
    http://www.telegraph.co.uk/money/main.jhtml?xml=/money/2008/03/23/ccfed123.xml

    When the Federal Reserve stepped in to save Bear Stearns, most people had no idea what was at stake, writes Ambrose Evans-Pritchard

    We may never know for sure whether the Federal Reserve's rescue of Bear Stearns averted a seizure of the $516 trillion derivatives system, the ultimate Chernobyl for global finance.
     

  • The financial crisis in full
  • Read more by Ambrose Evans Pritchard
  • Roger Bootle: This is a crisis but not The Great Depression

    "If the Fed had not stepped in, we would have had pandemonium," said James Melcher, president of the New York hedge fund Balestra Capital.

    "There was the risk of a total meltdown at the beginning of last week. I don't think most people have any idea how bad this chain could have been, and I am still not sure the Fed can maintain the solvency of the US banking system."

    All through early March the frontline players had watched in horror as Bear Stearns came under assault and then shrivelled into nothing as its $17bn reserve cushion vanished.

    Melcher was already prepared - true to form for a man who made a fabulous return last year betting on the collapse of US mortgage securities. He is now turning his sights on Eastern Europe, the next shoe to drop.

    "We've been worried for a long time there would be nobody to pay on the other side of our contracts, so we took profits early and got out of everything. The Greenspan policies that led to this have been the most irresponsible episode the world has ever seen," he said.

    Fed chairman Ben Bernanke has moved with breathtaking speed to contain the crisis. Last Sunday night, he resorted to the "nuclear option", invoking a Depression-era clause - Article 13 (3) of the Federal Reserve Act - to be used in "unusual and exigent circumstances".

    The emergency vote by five governors allows the Fed to shoulder $30bn of direct credit risk from the Bear Stearns carcass. By taking this course, the Fed has crossed the Rubicon of central banking.

    To understand why it has torn up the rule book, take a look at the latest Security and Exchange Commission filing by Bear Stearns. It contains a short table listing the broker's holding of derivatives contracts as of November 30 2007.

    Bear Stearns had total positions of $13.4 trillion. This is greater than the US national income, or equal to a quarter of world GDP - at least in "notional" terms. The contracts were described as "swaps", "swaptions", "caps", "collars" and "floors". This heady edifice of new-fangled instruments was built on an asset base of $80bn at best.

    On the other side of these contracts are banks, brokers, and hedge funds, linked in destiny by a nexus of interlocking claims. This is counterparty spaghetti. To make matters worse, Lehman Brothers, UBS, and Citigroup were all wobbling on the back foot as the hurricane hit.

    "Twenty years ago the Fed would have let Bear Stearns go bust," said Willem Sels, a credit specialist at Dresdner Kleinwort. "Now it is too interlinked to fail."

    The International Swaps and Derivatives Association says the vast headline figures in the contracts are meaningless. Positions are off-setting. The actual risk is magnitudes lower.

    The Bank for International Settlements uses a concept of "gross market value" to weight the real exposure. This is roughly 2 per cent of the notional level. For Bear Stearns this would be $270bn, or so.

    "There is no real way to gauge the market risk," said an official

    Continued in article


  • 2008
    Peter, Paul, and Barney: An Essay on 2008 U.S. Government Bailouts of Private Companies ---
    http://www.trinity.edu/rjensen/2008Bailout.htm


    2008
    "Officials Say They Sought To Avoid Bear Bailout," by Kara Scannell and Sudeer Reddy, The Wall Street Journal, April 4, 2008; Page A1 -- Click Here

    The government sought a low sale price for Bear Stearns Cos. to send a message that taxpayers wouldn't bail out firms making risky bets, a top Treasury Department official testified, as regulators offered Congress the first detailed explanation of the unprecedented rescue.

    Representatives of Washington and Wall Street painted a dire picture of the chaos they believe would have ensued if the government hadn't orchestrated a rescue of Bear Stearns by J.P. Morgan Chase & Co. over the hectic weekend of March 15-16.

    "This would have been far more, in my opinion, expensive to taxpayers had Bear Stearns gone bankrupt and added to the financial crisis we have today," said J.P. Morgan chief executive James Dimon. "It wouldn't have even been close."

    Officials said they were acutely aware of the moral-hazard problem, and that is why the government insisted that Bear Stearns shareholders get a low price for their shares. In the original deal, announced the night of March 16, J.P. Morgan agreed to pay $2 a share. After Bear Stearns shareholders protested, J.P. Morgan raised its price a week later to $10 a share -- still a fraction of the level Bear Stearns shares had traded at before it faced a funding crisis.

    "There was a view that the price should not be very high or should be towards the low end...given the government's involvement," Treasury Undersecretary Robert Steel told a congressional committee during a five-hour hearing Thursday.

    "These were exceptionally consequential acts, taken with extreme reluctance and care because of the substantial consequences it would have for moral hazard in the financial system," added Timothy Geithner, president of the Federal Reserve Bank of New York.

    Mr. Steel and other officials told the Senate Banking Committee that they didn't dictate the precise sale price, but wanted to see a deal done quickly to avoid a sudden market-shaking crash of the company.

    At the hearing, the first one focusing on the Bear Stearns rescue, lawmakers questioned top Fed officials, including Chairman Ben Bernanke, as well as the chief executives of Bear Stearns and J.P. Morgan. Held in a cavernous room reserved for big gatherings, rather than the more-intimate regular room, the hearing sometimes had the feel of a Hollywood red-carpet event as photographers descended on the panelists.

    Officials rejected lawmakers' suggestions that they bailed out Bear Stearns, noting that shareholders took steep losses and many employees may lose their jobs. But under questioning, Mr. Bernanke agreed with a lawmaker who suggested the Fed rescued Wall Street more broadly.

    "If you want to say we bailed out the market in general, I guess that's true," he said. "But we felt that was necessary in the interest of the American economy." He reiterated comments from a day earlier that the Fed doesn't expect to lose money on its $30 billion loan. J.P. Morgan has agreed to cover the first $1 billion in losses, if there are any.

    Mr. Dimon said his bank "could not and would not have assumed the substantial risk" of buying Bear without the Fed's involvement.

    At the hearing, the government and company officials gave an exhaustive account of the frenetic scramble in the days preceding the Bear Stearns sale. "We had literally 48 hours to do what normally takes a month," said Mr. Dimon.

    During the week of March 10, market rumors swirled that Bear Stearns might not be able to stay in business. At the hearing Alan Schwartz, Bear Stearns's chief executive, said that the firm's balance sheet was strong -- as good as that of any other financial institution -- but that Bear Stearns couldn't keep up with the rumors.

    By Thursday, March 13, the rumors had become a "self-fulfilling prophecy" and resulted in a "run on the bank," Mr. Schwartz said. Bear Stearns reached out to the regulators, who worked throughout the night. By Friday morning, March 14, the Fed agreed to extend financing to Bear Stearns through J.P. Morgan. Then the firms and government officials worked through the weekend to spur Bear Stearns's sale and prevent a bankruptcy filing.

    Along with the sale announcement on March 16, the Fed announced that it would lend directly to investment banks from its discount window, a historic reversal of its longtime policy of lending only to banks. While some have said that Bear Stearns could have avoided a sale if it had had access to the new lending program, Mr. Geithner said that wasn't feasible.

    "We only allow sound institutions to borrow against collateral," he said. "I would have been very uncomfortable lending to Bear given what we knew at that time."

    When it became clear that a deal had to happen before Asian markets opened late Sunday night, Bear Stearns's negotiating leverage "went out the window," said Mr. Schwartz. Among the parties examining Bear Stearns's books was a sophisticated buyer who was "prepared to write a multibillion check to invest in equity," but that would have required another financial institution to help finance the deal, Mr. Schwartz said. He didn't identify the potential buyer.

    Mr. Dimon testified that he couldn't recall whose idea it was to bring in the Fed. Treasury's Mr. Steel said it was J.P. Morgan that suggested the Fed's involvement.

    Continued in article


    2008

     

     
    SEC, Justice Scrutinize AIG on Swaps Accounting
    by Amir Efrati and Liam Pleven
    The Wall Street Journal

    Jun 06, 2008
    Page: C1
    Click here to view the full article on WSJ.com ---
    http://online.wsj.com/article/SB121271786552550939.html?mod=djem_jiewr_AC
     

    TOPICS: Advanced Financial Accounting, Auditing, Derivatives, Fair Value Accounting, Internal Controls, Mark-to-Market Accounting

    SUMMARY: The SEC "...is investigating whether insure American International Group Inc. overstated the value of contracts linked to subprime mortgages....At issue is the way the company valued credit default swaps, which are contracts that insure against default of securities, including those backed by subprime mortgages. In February, AIG said its auditor had found a 'material weakness' in its accounting. Largely on swap-related write-downs...AIG has recorded the two largest quarterly losses in its history."

    CLASSROOM APPLICATION: Financial reporting for derivatives is at issue in the article; related auditing issues of material weakness in accounting for these contracts also is covered in the main article and the related one.

    QUESTIONS: 
    1. (Introductory) What are collateralized debt obligations (CDOs)?

    2. (Advanced) What are credit default swaps? How are these contracts related to CDOs?

    3. (Advanced) Summarize steps in establishing fair values of CDOs and credit default swaps.

    4. (Introductory) What is a material weakness in internal control? Does reporting write-downs of such losses as AIG has shown necessarily indicate that a material weakness in internal control over financial reporting has occurred? Support your answer.
     

    Reviewed By: Judy Beckman, University of Rhode Island
     

    RELATED ARTICLES: 
    AIG Posts Record Loss, As Crisis Continues Taking Toll
    by Liam Pleven
    May 09, 2008
    Page: A1
     


    From The Wall Street Journal Accounting Weekly Review on June 13, 2008

    "SEC, Justice Scrutinize AIG on Swaps Accounting," by Amir Efrati and Liam Pleven, The Wall Street Journal,  June 6, 2008; Page C1 ---
    http://online.wsj.com/article/SB121271786552550939.html?mod=djem_jiewr_AC

    The Securities and Exchange Commission is investigating whether insurer American International Group Inc. overstated the value of contracts linked to subprime mortgages, according to people familiar with the matter.

    Criminal prosecutors from the Justice Department in Washington and the department's U.S. attorney's office in Brooklyn, New York, have told the SEC they want information the agency is gathering in its AIG investigation, these people said. That means a criminal investigation could follow.

    In 2006, AIG, the world's largest insurer, paid $1.6 billion to settle an accounting case. Its stock has been battered because of losses linked to the mortgage market. The earlier probe led to the departure of Chief Executive Officer Maurice R. "Hank" Greenberg.

    Officials for AIG, the SEC, the Justice Department and the U.S. attorney's office declined to comment on the new probe. A spokesman for AIG said the company will continue to cooperate in regulatory and governmental reviews on all matters.

    At issue is the way the company valued credit default swaps, which are contracts that insure against default of securities, including those backed by subprime mortgages. In February, AIG said its auditor had found a "material weakness" in its accounting.

    Largely on swap-related write-downs, which topped $20 billion through the first quarter, AIG has recorded the two largest quarterly losses in its history. That has turned up the heat on management, including CEO Martin Sullivan.

    AIG sold credit default swaps to holders of investments called collateralized-debt obligations, or CDOs, backed in part by subprime mortgages. The buyers were protecting their investments in the event of default on the underlying debt. In question is how the CDOs were valued, which drives both the value of the credit default swaps and the amount of collateral AIG must "post," or essentially hand over, to the buyer of the swap to offset the buyer's credit risk.

    AIG posted $9.7 billion in collateral related to its swaps, as of April 30, up from $5.3 billion about two months earlier.

    Law Blog: Difficulties in Valuation 'Best Defense'

    How much to bail out the banks now? $3.5 trillion by one estimate
    A federal program to guarantee or buy bad assets from the ailing U.S. bank sector could come with a $3.5 trillion price tag. That would push the accumulated costs of rescuing the financial markets over the last year through various federal loan, stock purchase, debt guarantee and other programs close to $9 trillion and counting, with practically no end in sight for the bad news battering the banking industry. That figure doesn't count the $825 billion economic stimulus plan also under consideration. "We expect massive federal intervention into the financial sector from the new administration in the coming months," says Keefe Bruyette & Woods analyst Frederick Cannon, who calculated the $3.5 trillion figure, which is one-quarter of the banking sector's $14 trillion in combined assets.
    Liz Moyer
    , "A TARP In The Trillions?" Forbes, January 21, 2009 --- http://www.forbes.com/2009/01/21/tarp-banking-treasury-biz-wall-cx_lm_0121tarp.html

    Lesson One: What Really Lies Behind the Financial Crisis?
    According to Siegel: Financial firms bought, held and insured large quantities of risky, mortgage-related assets on borrowed money. The irony is that these financial giants had little need to hold these securities; they were already making enormous profits simply from creating, bundling and selling them. 'During dot-com IPOs of the early 1990s, the firms that underwrote the stock offerings did not hold on to those stocks,' Siegel says. 'They flipped them. But in the case of mortgage-backed securities, the financial firms decided these were good assets to hold. That was their fatal flaw.'
    "Lesson One: What Really Lies Behind the Financial Crisis?" Knowledge@Wharton, January 21, 2009 ---
    http://knowledge.wharton.upenn.edu/article.cfm?articleid=2148
    Jensen Comment
    Lesson Two of what lies behind the financial crisis is that investment banks and others like AIG wrote credit derivatives on the on the CDO collateralized debt obligations that used mortgage backed securities as collateral. The companies that wrote these derivatives did not have the insurance reserves to cover the melt down of those CDOs. To avoid bankruptcy of giants such as AIG, the U.S. treasury gave billions in bailout funds to cover the credit derivatives.
    See Appendix E --- http://www.trinity.edu/rjensen/2008Bailout.htm#Bailout
    I think there was a hidden agenda with respect to why Hank Paulson's first billions in bailout funds went to cover the credit derivative obligations.
    See Appendix Y --- http://www.trinity.edu/rjensen/2008Bailout.htm#HiddenAgendaDetails

    Bob Jensen's threads on credit derivatives (scroll down) --- http://www.trinity.edu/rjensen/acct5341/speakers/133glosf.htm#C-Terms


    2008
    Question

    Securitization entails lending with collateral that, in the subprime crisis, was highly (and often fraudulently) overstated in value to outside investors in that collateralized debt. What can be done to save securitization in capital markets?

    "Coming Soon ... Securitization with a New, Improved (and Perhaps Safer) Face,   Knowledge@Wharton, April 2, 2008 ---
    http://knowledge.wharton.upenn.edu/article.cfm;jsessionid=a83051431af9532a7261?articleid=1933

    For generations, the strength of the U.S. housing market was due, in part, to securitization of mortgages with guarantees from the government-sponsored companies, Fannie Mae and Freddie Mac. Following the savings and loan debacle of the late 1980s, securitization -- which has been defined as "pooling and repackaging of cash-flow producing financial assets into securities that are then sold to investors" -- helped bring capital back to battered real estate markets.

    Today, securitization of subprime real estate loans is blamed for the global liquidity crisis, but Wharton faculty say securitization itself is not at fault. Poor underwriting and other weaknesses in the market for mortgage-backed securities led to the current problems. Securitization, they say, will remain an important part of the way real estate is funded, although it is likely to undergo significant change.

    "Securitization, in the long run, is a good thing," says Wharton finance professor Franklin Allen. "We didn't have much experience with falling real estate prices in recent years. The mechanisms weren't designed for that." He explains that economists were concerned about the incentives and accounting that shaped the private mortgage securitization market in recent years, but as long as real estate prices kept rising, the weaknesses in the system did not become clear. Now, after credit markets seized up and prices have declined sharply, those problems have been exposed.

    Allen believes financial markets will get back into the business of securitizing mortgage debt, but only after making some major changes. One new feature of future securitization deals, he says, could be a requirement that loan originators hold at least part of the loans they write on their books. Before the current crisis, loans were bundled into complex tranches that were passed through the financial system and onto buyers with little ability to assess the real value of the individual assets.

    "The way the collateralized debt obligations (CDOs) and other vehicles are structured will change. They are too complicated," says Allen. "I'm sure the industry will figure out how to do it. There will be a lot of industry-generated reform and the industry will prosper. This is not, in my view, something that should be regulated."

    Privatizing Securitization

    According to Wharton finance professor Richard J. Herring, for decades, mortgage securitization was backed by government guarantees through Fannie Mae and Freddie Mac, and it worked well. Of course, these agencies were regulated and bound by less-risky underwriting standards than those that ultimately prevailed in the subprime market which was also, potentially, more profitable. Indeed, default rates were so low in the mortgage-based securities market that banks and other private financial institutions were eager to take a piece of the residential business.

    At first, the transition to private securitization worked, because investors were willing to rely on three substitutes for the government guarantees. These included ratings agencies, new business models and monoline insurance designed to guarantee specialized mortgage-backed bonds. "Positive experience with private securitization led to an alphabet soup of innovations that sliced and diced the cash flows from pools of mortgages in increasingly complex ways," says Herring.

    Now, the subprime crisis has undermined confidence in all three pillars of private securitization. Ratings proved unreliable as even highly rated tranches experienced sudden, multiple-notch downgrades that were unknown in corporate bonds. Models developed by the most sophisticated firms selling mortgage-backed securities, including Bear Stearns, Merrill Lynch, Citigroup and UBS, failed. Monoline insurers, it turned out, were not adequately capitalized.

    "There has been a highly rational flight to simplicity," says Herring. Over time, he believes, the real estate securitization market will reemerge as investors regain confidence in the ratings agencies, new models evolve, and monoline insurers are able to increase their capital. "But I think that it will be a long time before the market will be willing to accept the complex, opaque structures that failed," continues Herring. He adds that recovery will be delayed until investors are confident that the fall in house prices has reached the bottom.

    Wharton real estate professor Susan M. Wachter points out that many recent -- and historic -- international financial problems originated in real estate. The nature of real estate finance and incentive structures is more to blame than securitization this time around. "The most recent crisis is coming through the securitization market, but this isn't the only real estate crisis," Wachter notes, adding that the fundamental problem in real estate finance is that there is no way to bet against the industry. Real estate is essentially priced by optimists, and rising prices themselves justify even higher values as assets are marked to market, creating new incentives for investors to overpay.

    Wachter points to real estate investment trusts (REITS), publicly traded bundles of real estate assets, as an example of how securitization can help provide liquidity, but also a chance for short-sellers to correct against overly optimistic pricing. Research indicates that REIT prices may not have increased as much as other sectors of real estate finance because the industry has at least 200 analysts looking at the underlying assets in each REIT with the ability to point out faulty pricing to investors. "REITS have performed fluidly relative to the overall market, and that is a good thing," says Wachter.

    Fee-driven Lending

    Another problem was that much of the subprime lending was fee-driven, giving banks incentives to write loans to earn the fees because they could then pass the risky assets along to securitized bondholders. And even bank shareholders had no way to limit their real estate exposure because banks invest in various kinds of economic activity and not just in real estate. Biased pricing and bubbles also arise because the supply of real estate is not elastic. By the time the market recognizes supply has outstripped demand, construction has already begun on many more projects that will continue to be built out; this tends to exacerbate oversupply and create downward pressure on prices for years.

    In a research paper titled, "Incentives for Mortgage Lending in Asia," Wachter and her co-authors write: "With [the] forbearance of regulatory authorities and the intervention of governments, banks may be bailed out, mitigating the consequences for shareholders. Nonetheless, the fundamental factor which explains why episodes of bank under-pricing of risk are likely to occur is the inability of banking shareholders to identify these episodes promptly and incentivize correct pricing."

    Wharton real estate professor Joseph Gyourko notes that significant differences exist in the performance of commercial and residential real estate securities. "Securitized commercial property debt will come back once the market calms down," he says, adding that there has been very little default in commercial real estate finance. "You'll be able to pool mortgages and securitize them, but almost certainly won't be able to leverage them as much as you did in the past."

    The residential side, where there is significant default, is more problematic. Gyourko believes the residential market will go back to what it was in the mid-1990s and most borrowers will have to put down at least 10% of the sales price. "We will get rid of the exotic, highly leveraged loans," he says. "That will lead to lower homeownership, but it should. We put a lot of people into homeownership that we shouldn't have."

    Wharton emeritus finance professor Jack Guttentag, who runs a web site called mtgprofessor.com, says the short-term future for residential real estate is "bleak."

    "Secured bondholders have been badly burned. They discovered to their dismay that all kinds of problems are connected to mortgage-backed securities, which they hadn't anticipated." Guttentag also points to the failure of ratings agencies, which are already being revamped. The methodologies used to determine ratings were flawed, he says. "They used historic performance over a period that simply wasn't representative."

    "CDOs are Doomed"

    In the future, ratings agencies will need to operate on the assumption that a security rated AAA should be able to withstand a shock as great as the current crisis.

    "That will mean that under the best of circumstances, it will be harder to get a triple-A rating, which will reduce the profitability of securities," Guttentag says. Some forms of securities will die. CDOs are doomed, he adds, because the market has seen they are extremely difficult to value. "In the short term, the prospects are dismal. The market will recover, but I don't think we'll ever see CDOs again and the standards will be tougher, so the comeback will be gradual."

    Gyourko notes that the crisis is playing out in a presidential election year, complicating the response. "I think this is the worst time to have this happen. It's never a good time, but in an election year, you're more likely to get a bad policy response," he says. According to Guttentag, while Republican presidential candidate John McCain is taking a laissez-faire stance, the Democratic presidential candidates have focused on using the Federal Housing Administration (FHA) to refinance loans that are in default. The idea is similar to what happened during the Great Depression of the 1930s with another agency called the Home Owners' Loan Corp. which was created specifically for that purpose.

    The problem, says Guttentag, is that FHA is not designed as a bailout agency. "The FHA's core mission is predicated on it being a solvent operation, actuarially sound, charging an insurance premium large enough only to cover losses. How they would reconcile that is not clear."

    Guttentag says attempts may be made to create a separate bailout agency within the FHA with different accountability. "But the devil is in the details," he warns, "and the details have to do with exactly who is going to be helped, what the requirements are, what the nature of the assistance is going to be, and myriad other factors that have to be worked out." The Bush administration has taken some steps to ease the crisis, including encouraging lenders to modify contracts to avoid foreclosure. A strong case can be made for these measures, Guttentag adds. "The cost of foreclosure is often greater than the cost of modifying the contract and keeping the borrower in the house." One downside is that once some loans are modified for those truly on the brink of foreclosure, other borrowers who could somehow manage to avoid foreclosure may demand the same modifications, shortchanging investors.

    In testimony before the U.S. House of Representatives' Committee on Oversight and Government Reform, Wachter laid out a proposal developed with the Center for American Progress to resolve the current crisis. Under the so-called SAFE loan plan, the U.S. treasury and the Federal Reserve would run auctions, in which FHA originators, as well as Fannie Mae and Freddie Mac and their servicers, would purchase mortgages from current investors at a discount determined at the auction.

    Investors would take a reduction in asset value and yield in exchange for liquidity and certainty and the auction process would price pools and bring transparency back to the market. The FHA, Fannie Mae, and Freddie Mac could then arrange for restructuring of loans.

    Meanwhile, Allen notes the Federal Reserve has taken some dramatic steps with interest rate policy to resolve the current economic crisis, but that could lead to tension with Europe and Japan over currency valuations. As the dollar continues to fall, U.S. companies are increasingly more competitive overseas. "The Fed cut the rate at the beginning, and that was fine, but now things are getting way out of line," he says.

    Furthermore, it is not clear that cutting rates is going to solve the basic problem. As rates continues to drop, foreigners may begin withdrawing their money from dollar-denominated investments, driving rates up. "What the Fed is doing is unprecedented," says Allen. "It is laudable that it is trying to stop a recession, but how many risks should you take to do that? We're now moving into an area where the Fed is probably taking too many risks. If inflation picks up and long-term rates go up, we'll be in a situation where we have to raise short-term rates as we go into recession, which is not a happy thing to."

    Vulture Capital

    The private sector has begun to show signs of willingness to get back into the fray. A number of vulture funds have begun to form to take advantage of distressed real estate prices. BlackRock and Highfields Capital Management have announced they will raise $2 billion to buy delinquent residential mortgages. The companies have hired Sanford Kurland, the former president of Countrywide Financial, to run the new venture called Private National Mortgage Acceptance, or PennyMac. "Many distressed funds will come in to discover prices," says Gyourko.

    Wharton real estate professor Peter Linneman offers an intriguing prescription to bring prices down to the point where the industry can start to rebuild. He suggests that the government tell banks that if they want to maintain their federal insurance, they should fire their CEO by the end of the day, and the government will pay the CEO $10 million in severance. Ousting the former CEOs gives the new bank CEOs an incentive to write down all the bad assets immediately, so that any improvement will make them look good going forward. That would speed the painful process of gradual price declines.

    "There's plenty of money out there waiting for these assets to be written down to bargain prices," says Linneman. In another quarter or two, the lenders would have new cash and be ready to lend again. Meanwhile, he says, the government should tell bankers it will keep interest rates down but raise them after the end of the year. "That says, 'Get your house in order in the next nine months because the subsidy ends at the end of the year.'" Linneman figures that 1,000 CEOs are accountable for about 80% of the current lending mess. If the government were to spend $10 billion to restore liquidity to the market in nine months with only 1,000 people losing their jobs, it would be the best investment it could make to restore the economy. "I'm only half-kidding," he quips.

    Linneman also argues that concerns about moral hazard -- or the tendency to take greater risks because of the presence of a safety net -- because of a bailout are not valid. Those concerns, he says, already exist and have been in place since the U.S. government agreed to insure bank deposits. "The minute you say to somebody, 'No matter what you do I'll give your people their money back,' you've created moral hazard," he says. "Now it's only a matter of how often and how much they will have to spend to settle up. If you go through our history, every eight years to 15 years we have had an episode."

    Continued in article

    The Timeline of the Recent History of Fannie Mae Scandals 2002-2008 --- http://www.trinity.edu/rjensen/caseans/000index.htm#FannieMae
    "Fannie Mayhem: A History," The Wall Street Journal, July 14, 2008


    2008

    "Merrill Lynch Settlement With SEC Worth Up to $7B," SmartPros, August 25, 2008 --- http://accounting.smartpros.com/x62971.xml

    Federal regulators said Friday that investors who bought risky auction-rate securities from Merrill Lynch & Co. before the market for those bonds collapsed will be able to recover up to $7 billion under a new agreement.

    The largest U.S. brokerage will buy back the securities from thousands of investors under a settlement with the Securities and Exchange Commission, New York Attorney General Andrew Cuomo and other state regulators over its role in selling the high-risk bonds to retail investors. Under that deal, announced Thursday, Merrill agreed to hasten its voluntary buyback plan by repurchasing $10 billion to $12 billion of the securities from investors by Jan. 2.

    Merrill also agreed to pay a $125 million fine in a separate accord with state regulators.

    The $330 billion market for auction-rate securities collapsed in mid-February.

    The SEC's estimate of a $7 billion recovery is based on its projection of the eventual amount of the bonds that will be cashed in by the affected investors, who bought them before Feb. 13. The $10 billion to $12 billion is the total amount that Merrill is committing to buy back. The firm has to offer redemptions to all investors, though not all may cash in the securities.

    The SEC said the new agreement will enable retail investors, small businesses and charities who purchased the securities from Merrill "to restore their losses and liquidity."

    New York-based Merrill neither admitted nor denied wrongdoing in agreeing to the federal settlement, which is subject to approval by SEC commissioners.

    The firm wasn't fined under the accord, but the SEC said Merrill "faces the prospect" of a penalty after completing its obligations under the agreement. The amount of the penalty, if any, would take into account the extent of Merrill's misconduct in marketing and selling auction-rate securities, and an assessment of whether it fulfilled its obligations, the SEC said.

    "Merrill Lynch's conduct harmed tens of thousands of investors who will have the opportunity to get their money back through this agreement," Linda Thomsen, the agency's enforcement director, said in a statement. "We will continue to aggressively investigate wrongdoing in the marketing and sale of auction-rate securities."

    Merrill, Goldman Sachs Group Inc. and Deutsche Bank on Thursday brought to eight the number of global banks that have settled a five-month investigation into claims they misled customers into believing the securities were safe.

    The auction-rate securities market involved investors buying and selling instruments that resembled regular corporate debt, except the interest rates were reset at regular auctions - some as frequently as once a week. A number of companies and retail clients invested in the securities because, thanks to the regular auctions, they could treat their holdings as liquid, almost like cash.

    Major issuers included companies that financed student loans and municipal agencies like the Port Authority of New York and New Jersey. When big banks ceased backstopping the auctions with supporting bids because of concerns about credit exposure, the bustling market collapsed. That left some issuers paying double-digit interest rates because of the terms under which they issued the securities.

    Regulators have been investigating the collapse in the market to determine who was responsible for its demise and whether banks knowingly misrepresented the safety of the securities when selling them to investors.

    Jensen Comment
    It's unbelievable how many huge frauds there are in which Merrill Lynch has been an active participant. For example, go to the top of this document and do a word search for "Merrill."
    For example, Merrill Lynch was a key player in the derivatives instrument fraud that cost Orange County over a billion dollars. This is just one of the many examples.


    2008
    "Former Diebold Sales Rep Settles Inside Trading Charges," Securities Law Prof Blog, November 26, 2008 ---
    http://lawprofessors.typepad.com/securities/ 

    On November 19, 2008, the United States District Court for the Western District of Oklahoma entered final judgment against Robert G. Cole in SEC v. Cole, Civ 08-265 C (W.D. Okla.), an insider trading case the Commission filed on March 13, 2008. The Commission’s complaint alleged that Cole, a former sales representative for Diebold, Inc., made over $500,000 in illegal profits by using material, nonpublic information to trade Diebold securities. Diebold is an Ohio-based public company that manufactures and sells automated teller machines, bank security systems, and electronic voting machines.

    The Commission’s complaint alleged that on September 15, 2005, shortly after learning from his sales manager that revenues and orders in Diebold’s North American regional bank business were significantly below target, Cole began purchasing hundreds of soon-to-expire Diebold put options contracts, at a total cost of $70,110, anticipating that Diebold would lower its earnings forecast and the price of Diebold stock would fall. As alleged in the complaint, on September 21, 2005 — one day after Cole completed purchasing these Diebold put option contracts — Diebold announced that it was lowering its earnings forecasts, primarily because of a revenue shortfall in the company’s North American regional bank business. After this public announcement, Diebold’s stock price dropped sharply, closing at $37.27 per share, which was a 16% drop from the previous day’s closing price of $44.13. As the complaint alleged, Cole immediately sold the Diebold put option contracts for $579,190, realizing illicit profits of $509,080 (a 700% return).

    The Commission alleged that Cole violated Section 10(b) of the Securities Exchange Act of 1934, and Rule 10b-5 thereunder. Without admitting or denying the allegations in the complaint, Cole consented to the entry of a final judgment that permanently enjoins him from future violations of these provisions, and orders him to disgorge his illicit profits of $509,080, which will be deemed satisfied by a forfeiture order entered in a related criminal case. In that case, U.S. v. Robert Cole, No. 5:08-CR-327 (N.D. Ohio), Cole pled guilty to a felony charge of securities fraud, and was sentenced to a prison term of 1 year and 1 day, two years of supervised release, forfeiture of $509,080, and a $180,000 fine.

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

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

     


    2008
    "French Bank Rocked by Rogue Trader Société Générale Blames $7.2 Billion in Losses On a Quiet 31-Year-Old," by David Gauthier-Villars, Carrick Mollenkamp, and Alistair MacDonald, The Wall Street Journal, January 25, 2008; Page A1 ---
    http://online.wsj.com/article/SB120115814649013033.html?mod=djem_jiewr_ac


    2008
    "Derivatives the new 'ticking bomb' Buffett and Gross warn: $516 trillion," by Paul B. Farrell, Market Watch, March 10, 2008 --- Click Here 

    Wall Street didn't listen to Buffett. Derivatives grew into a massive bubble, from about $100 trillion to $516 trillion by 2007. The new derivatives bubble was fueled by five key economic and political trends:
    1. Sarbanes-Oxley increased corporate disclosures and government oversight
    2. Federal Reserve's cheap money policies created the subprime-housing boom
    3. War budgets burdened the U.S. Treasury and future entitlements programs
    4. Trade deficits with China and others destroyed the value of the U.S. dollar
    5. Oil and commodity rich nations demanding equity payments rather than debt

    In short, despite Buffett's clear warnings, a massive new derivatives bubble is driving the domestic and global economies, a bubble that continues growing today parallel with the subprime-credit meltdown triggering a bear-recession


    2008

    A Primer on Derivatives

    I think there are two CBS Sixty Minutes television modules by Steve Kroft that the entire world should view. These are great videos for college students to view while keeping in mind that both videos are negatively biased. What follows is my primer in defense of derivative financial instruments and hedging activities.

    CBS Video Module 1
    Financial Derivatives Scandals Explode in 1995

     

     

    CBS Video Module 2
    Credit Derivatives Scandals Explode in 2008
    •  Steve Kroft on Sixty Minutes, October 26, 2008 ---
      Introductory Segment if Credit Default Swaps --- http://www.cbsnews.com/video/watch/?id=4501762n%3fsource=search_video
      This video features my hero, Frank Partnoy, who has a great set of books on derivatives scandals (he was once a crook). Frank Partnoy's Senate testimony is the probably the best explanation of how Enron cheated with derivatives --- http://www.trinity.edu/rjensen/FraudEnronQuiz.htm#16
      The Year 2000 controversial law referred to in the video is the Commodity Futures Modernization Act of 2000 --- http://en.wikipedia.org/wiki/Commodities_Futures_Modernization_Act
      Also see http://knowledge.wpcarey.asu.edu/article.cfm?articleid=1682
       
    • Examples of derivative contracts that even the professional analysts could not decipher  and a history of derivatives contracting scandals --- http://www.trinity.edu/rjensen/fraud.htm#DerivativesFraud 
       
    • A Great Slide Show on Credit Derivatives --- http://www.isda.org/c_and_a/ppt/PRMIAISDAFinal.ppt#261,10,Modelling Legal Risk?
      Or view the HTML version --- Click Here
       
    • Frank Partnoy is best known as a whistle blower at Goldman Sachs who blew the lid on the financial graft and sexual degeneracy of derivatives instruments traders and analysts who ripped the public off for billions of dollars and contributed to mind-boggling worldwide frauds.  He is a Yale University Law School graduate who shocked the world with various books  (somewhat repetitive) including the following:
      • FIASCO: The Inside Story of a Wall Street Trader
      • FIASCO: Blood in the Water on Wall Street
      • FIASCO:  Blut an den weißen Westen der Wall Street Broker.
      • FIASCO: Guns, Booze and Bloodlust: the Truth About High Finance
      • Infectious Greed : How Deceit and Risk Corrupted the Financial Markets
      • Codicia Contagiosa

      His other publications include the following highlight:

      "The Siskel and Ebert of Financial Matters: Two Thumbs Down for the Credit Reporting Agencies" (Washington University Law Quarterly)

       

     

    Related to the above television programs is "The Trillion Dollar Bet" video from PBS Nova --- http://www.trinity.edu/rjensen/2008Bailout.htm#LTCM
     

    Bob Jensen's Primer on Derivatives
    Although the roots of the sub-prime mortgage scandal lie in Main Street lending or more money for housing than borrowers could ever afford to pay off, the opportunity to do so was afforded by lenders like Countrywide Financial (a mortgage lending company owned by Bank of America) being able to pass on the default risk by selling the high risk mortgages to Fannie Mae and Freddie Mac, quasi government corporations that took the brunt of the loan losses. But some banks like Washington Mutual (WaMu became the largest bank failure in the history of the world) were greedy and kept huge portfolios of these high-return and high-risk mortgage investments.

    Fannie, Freddie, WaMu and the other risk takers assumed that the value of the real estate (the mortgage loan collateral) would be sufficient to pay back the loans in case of mortgage default foreclosures. But they underestimated the fraud going on on Main Street where property appraisers were fraudulently estimating real estate values way above market value and mortgage companies were lending way above amounts that borrowers would ever be able to pay back. My essay on the sub-prime mortgage scandal along with an alphabet soup set of appendices can be found at http://www.trinity.edu/rjensen/2008Bailout.htm

    In addition much of the current scandal also is attributed to Wall Street writing of credit derivative contracts that essentially "insured" against default of debt with counterparties investing in debt instruments that were "insured" by credit derivatives written by such giant firms as Bear Stearns and American Insurance Group (AIG). But unlike insurance where sufficient capital reserves are required, Congress passed legislation in Year 2000 that allowed Wall Street to write credit derivative insurance without having any capital reserves to cover the losses. Congress and the Wall Street firms just never anticipated the massive amount of mortgage defaults attributable to Main Street's lending frauds. When the magnitude of the amounts owing to counterparties on credit derivatives became known, giant firms like Bear Stearns and AIG would've defaulted due to credit derivative obligations to counterparties. This would have led, in turn,  to counterparty failure of many giants in the world banking system. The Federal Reserve decided early on to bail out Bear Stearns credit derivative losses, and the first $70 billion given to AIG by Hank Paulsen in the new Bailout Bill went to pay off AIG's counterparties to AIG's credit derivative contracts --- http://www.trinity.edu/rjensen/2008Bailout.htm#SEC

    So what is a derivative financial instrument? Consider first a financial debt instrument that historically was a contract in which a borrower borrowed money from a lender and the risk for the entire notional (the loan principal) passed from borrower to lender. For example, if Company B sold bonds for $100 million to Company C, the entire notional ($100 million) is at risk of being paid back to Company B. Credit rating companies, in turn, rate those bonds as to financial risk with such ratings as AAA (virtually certain to be paid back) all the way down to junk bonds (very high risk of default) of the entire notional amount. Credit ratings greatly impact the price received by Company B for its bond sales.

    A derivative financial instrument is similar except that the notional amount is often not at risk because these contracts "net settle." For example, if Airline A enters into futures contracts to buy a million gallons of jet fuel one year from now at a forward price of $4 per gallon, the notional full value of a million gallons of fuel never changes hands. After a year passes, Airline A net settles with the counterparties on the net difference between the current spot price and the contracted forward price. Although in some cases a purchase/sale contract can specify physical delivery of the notional, most derivative contracts net settle without putting the entire notional amount at risk.

    Hence, a derivative financial instrument has a notional (a quantity such a a million bushels of corn), an underlying (such as the market price of a particular grade of corn), and net settlement provisions that do not put the value of the entire notional amount at risk. Only the difference between forward and spot prices on the notional is at risk. The entire notional becomes at risk only if the future spot prices fall to zero or nearly zero. This is not likely to happen in the case of commodities like corn, oil, copper, gold, silver, etc. It can happen in the case of credit ratings where $100 million in AAA bonds fall to zero when the debtor is declared to be hopelessly bankrupt. This is why credit derivatives are much more risky than commodity derivatives. If a credit derivative is written on a $100 million bond contract, the entire $100 million might be lost. The probability of losing the entire value of the notional is much greater with credit derivatives than with commodities that are almost certain not to decline to $0 in value.

    The underlying is generally called an index. Examples include corn prices, oil prices, interest rates (e.g., Treasury rates or LIBOR rates), and credit ratings (AAA, AAB, BBB, etc.). A huge difference between commodity versus credit derivatives lies in the depth (number of buyers and sellers) and the frequency of trades in the market. For example, in the derivatives markets for corn futures or corn options (puts and calls) there are thousands upon thousands of buyers and sellers and the market prices (e.g., futures, option, and spot prices) change by the minute each trading day. In the case of a credit derivative written on the bond rating by a credit rating agency there is no deep market and the credit rating rarely changes. There is no underlying "market" in the case of a credit derivative. Hence a credit derivative differs fundamentally from a commodity derivative in the depth of the market and the frequency of trading on the market. Its a mistake to lump credit derivatives and commodity derivatives in the same a single type of contracting called derivatives.

    By any other name, a credit derivative is an insurance contract where risk of default is not market based but depends upon some disaster just like casualty insurance protects against such disasters as fire, wind, and flood. The entire value of the notional (the entire value of each bond insured for credit risk or each house insured for fire loss) is at risk.

    In contrast, a commodity derivative is market based and does not in general put the the entire notional at risk because commodity values are not likely to be wiped out entirely. Commodities may move up and down in value, thereby generating variations in the basis (which is the difference between spot and forward prices), but it would be extremely rare for the a commodity to fall to zero in value. It is much more common for an insured house to be burned down entirely or an insured (with a credit derivative) bond notional to fall into junk bond status.

    AIG and Allstate and State Farm are required by insurance laws to have capital reserves to cover a large number of houses burning down at the same time. However, if all insured houses burned down at the same time, insurance companies could not possibly cover all the losses. This is why a single insurance company might refuse to insure more than a certain percentage of houses in a give geographic area. Insurance written above a company's limit is spread to other companies by a process called reinsurance. Insurance companies are subject to regulation that requires capital reserves to cover actuary-determined expected losses and contract clauses that limit risk in case of catastrophes such as nuclear holocaust.

    Credit derivative insurers could not write insurance contracts for credit default without capital reserves and other catastrophe clauses until Congress in Year 2000 allowed investment banks like Bear Stearns and insurance underwriters like AIG to enter into credit derivative insurance without capital reserves and catastrophe clauses. The fraudulent sub-prime loan market became a catastrophe in terms of real estate loans covered against default by credit derivatives. Bear Stearns, AIG, and the other credit derivative underwriters had insufficient capital reserves and would've defaulted on their credit derivatives if the U.S. government had not stepped in to cover amounts owed to credit derivative counterparties. The government justified bailing out these obligations by stating that the domino effect would've otherwise brought down the entire banking system. On this I'm a cynic, but that's another matter entirely. History is history at this point.

    What is sad today is that derivatives in general are getting a bad name!
    Commodity derivatives (including interest rate risk derivatives) are great vehicles for managing financial risk provided the commodities and their derivatives are both traded in deep markets with virtually zero probability that commodity values will fall to zero. Sadly, most people in the world just do not appreciate the importance of maintaining active commodity derivative markets for managing risk.

    Ignorant people, especially ignorant members of congress, may move to ban or severely restrain all derivative markets rather than to merely reclassify credit derivatives as insurance contracts subject to insurance laws. This does not mean, however, that I think that commodity derivative contracting should be more regulated for protection against unscrupulous sellers of derivative contracts. Like my hero Frank Partnoy, I've argued for years that there should be more regulation of sellers of derivative contracts.

    I have a detailed history of derivative instrument contract scandals and the evolution of accounting rules (national and international) for derivative contracts at http://www.trinity.edu/rjensen/FraudCongress.htm#DerivativesFrauds
    At each point in the way I've applauded Frank Partnoy's appeal for both expanded use of derivative instruments for managing risk and expanded regulations to stop firms like Merrill Lynch, Morgan Stanley, and other unscrupulous outfits from writing derivatives with built-in financial complexity intended to obscure risk and screw fund investors who did not understand what they were buying into.

    Bob Jensen's free tutorials and videos on complex accounting rules for accounting for derivative financial instruments and hedging activities --- http://www.trinity.edu/rjensen/caseans/000index.htm

    Bob Jensen's glossary on derivative financial instruments --- http://www.trinity.edu/rjensen/acct5341/speakers/133glosf.htm

    If Greenspan Caused the Subprime Real Estate Bubble, Who Caused the Second Bubble That's About to Burst?
    Answer:  See http://www.trinity.edu/rjensen/2008Bailout.htm#LiquidityBubble

     


    2008
    In March 2008 the United States Financial Accounting Standards Board (FASB) issued the FAS 161 amendments of FAS 133. These amendments pertain to disclosures of derivative financial instruments.

    The use and complexity of derivative instruments and hedging activities have increased significantly over the past several years. Constituents have expressed concerns that the existing disclosure requirements in FASB Statement No. 133, Accounting for Derivative Instruments and Hedging Activities, do not provide adequate information about how derivative and hedging activities affect an entity’s financial position, financial performance, and cash flows. Accordingly, this Statement requires enhanced disclosures about an entity’s derivative and hedging activities and thereby improves the transparency of financial reporting. This Statement is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008, with early application encouraged. This Statement encourages, but does not require, comparative disclosures for earlier periods at initial adoption.

    This Statement is intended to enhance the current disclosure framework in Statement 133. The Statement requires that objectives for using derivative instruments be disclosed in terms of underlying risk and accounting designation. This disclosure better conveys the purpose of derivative use in terms of the risks that the entity is intending to manage. Disclosing the fair values of derivative instruments and their gains and losses in a tabular format should provide a more complete picture of the location in an entity’s financial statements of both the derivative positions existing at period end and the effect of using derivatives during the reporting period. Disclosing information about credit-risk-related contingent features should provide information on the potential effect on an entity’s liquidity from using derivatives. Finally, this Statement requires cross-referencing within the footnotes, which should help users of financial statements locate important information about derivative instruments.

    1. FASB Statement No. 133, Accounting for Derivative Instruments and Hedging Activities, establishes, among other things, the disclosure requirements for derivative instruments and for hedging activities. This Statement amends and expands the disclosure requirements of Statement 133 with the intent to provide users of financial statements with an enhanced understanding of:

    a. How and why an entity uses derivative instruments

    b. How derivative instruments and related hedged items are accounted for under Statement 133 and its related interpretations

    c. How derivative instruments and related hedged items affect an entity’s financial position, financial performance, and cash flows.

    To meet those objectives, this Statement requires qualitative disclosures about objectives and strategies for using derivatives, quantitative disclosures about fair value amounts of and gains and losses on derivative instruments, and disclosures about credit-risk-related contingent features in derivative agreements.

    2. This Statement has the same scope as Statement 133. Accordingly, this Statement applies to all entities. This Statement applies to all derivative instruments, including bifurcated derivative instruments (and nonderivative instruments that are designated and qualify as hedging instruments pursuant to paragraphs 37 and 42 of Statement 133) and related hedged items accounted for under Statement 133 and its related interpretations.


    2008
    Question
    What could "swaps", "swaptions", "caps", "collars" and "floors"have to do with the value of your home and the pillars of the banking enterprise?

    "Pushovers at the Fed," The Wall Street Journal,  March 25, 2008; Page A22 ---
    http://online.wsj.com/article/SB120640465860361041.html?mod=djemEditorialPage

    Last week's Fed-led sale of Bear at least had the virtue of sending a message that bad things happen to reckless investors. Bear took a highly leveraged flyer on the mortgage securities market, ran into a liquidity crisis as its creditors lost confidence, and had to ask the Fed for help to avoid bankruptcy. The $2 sale price was a shock to Bear employees and investors. But it was also condign market punishment for bad decisions, and a bracing lesson for future investors. Meanwhile, the Fed's more troubling agreement to guarantee Bear's mortgage paper could at least be justified in the name of avoiding a larger financial breakdown.  . . .  If Bear holders don't like the $2 price, they have every right to oppose it while taking their chances with customers and creditors. If Mr. Dimon wants to pay more for Bear, that's also his prerogative, but then he shouldn't demand that the Fed continue to guarantee his paper. He's getting Bear at such a great price that he ought to accept the mortgage-backed securities risk almost as a public service. We suspect that's what the J.P. Morgan of the Panic of 1907 would have done . . . The immediate political message is also terribly damaging. Congress is already poised to overreact to the mortgage turmoil with a general bailout for subprime borrowers, and yesterday's actions will only feed that beast. At least the $2 share price wasn't a bailout for Bear shareholders; at $10 a share, that's a harder argument to sell, especially when taxpayers are also still indemnifying those Bear-J.P. Morgan creditors. This makes us wonder if Treasury Secretary Hank Paulson isn't already preparing to cave to Congress on the larger bailout.


    2008
    "The Accounting Cycle Biovail Exposed, Part II," by: J. Edward Ketz , SmartPros, April 2008 ---
    http://accounting.smartpros.com/x61530.xml

    "Are Derivatives Too Complex? Is It Time to Regulate Their Usage?" by J. Edward Ketz, SmartPros, March 20, 2008 --- http://accounting.smartpros.com/x61241.xml 


    2008
    The Worldwide Oligopoly of Audit Firms
    Question:  How much have audit fees allegedly increased since auditors put on their SOX?

    "On with the show? The auditing business, concentrated in the hands of just a few companies, is far too cosy to operate with consumers' best interests in mind," by Prim Sikka, The Guardian, June 3, 2008 --- http://commentisfree.guardian.co.uk/prem_sikka_/2008/06/on_with_the_show.html

    Never mind showbusiness, there's no business like the accountancy business. Accountancy firms have a licence to print money because they enjoy access to a state-guaranteed market for auditing. Companies, hospitals, schools, charities, universities, trade unions and housing associations have to submit to an audit, even though the auditor might issue duff reports. Anyone refusing their services faces a prison sentence.

    Major company audits are the most lucrative and that market is dominated by just four global auditing firms. PricewaterhouseCoopers, Deloitte, KPMG and Ernst & Young have global revenues of over $80 billion (£41bn) a year, which is exceeded by the gross domestic product of only 54 nation states. These firms dominate the structures that make accounting and auditing rules.

    Following the Enron and WorldCom debacles and the demise of Arthur Andersen, the auditing market has become further concentrated in those four firms. Many major companies looking for global coverage find that the auditor choice is very restricted.

    In the US, the big four audit 95% of public companies with market capitalisations of over $750m. A US study focusing on 1,300 companies, showed that the fees charged by the big auditing firms have increased by 345% in the five years to 2006. Median total auditor costs rose to $2.7m, from $1.4m in 2001. A major reason for the increase is said to be the (SOX) Sarbanes-Oxley Act (pdf) 2002, which was introduced after audit failures at Enron and WorldCom.

    In the UK, the big four firms audit 97% of FTSE 350 companies. In 2001, the average FTSE 100 company audit fee was £1.89m. By 2006, the figure had increased to £3.7m. The rise in audit fees continues to exceed the rates of inflation. For example, Northern Rock's fees have increased from £1.8m in 2006 to £2.4m in 2007.

    The firms cite the Sarbanes-Oxley Act and international accounting and auditing standards to justify higher fees. They are silent on the fact that their own audits of Enron and WorldCom arguably prompted the Sarbanes-Oxley Act, or that the big four firms finance and dominate the setting of international accounting and auditing standards. These standards rarely say anything about the public accountability of auditing firms. Most firms refuse to reveal their profits.

    The massive hike in audit fees has not given us better audits. Carlyle Capital Corporation collapsed within days of receiving a clean bill of health form its auditors. Bear Stearns was bailed out within a few days of receiving another clean bill of health. In the current financial crisis, all major banks received a clean bill of health even though they engaged in massive off balance sheet accounting and around $1.2tn of toxic debts may have been hidden. But perhaps ineffective auditors suit the corporate barons.

    In market economies, producers of shoddy goods and services are allowed to go to the wall. Governments impose higher standards of care on them to improve quality. But entirely the opposite has happened in the auditing industry. Auditing firms have secured liability concessions (pdf) to shield them from the consequences of own their failures. Charlie McCreevy, the EU commissioner for the internal market and services, an accountant, is keen to give them more. He favours an artificial "cap" on auditor liability. The commissioner has failed to provide any evidence to show that the liability shield provided to producers of poor quality goods and services somehow encourages them to improve the quality of their products.

    Accountancy firms, EU commissioners and regulators routinely preach competition to everyone else, but go soft when it comes to dealing with auditing firms. They could restrict the number of FTSE companies that any auditing firm can audit and thus create for space for medium-sized firms to advance. They could insist that some quoted companies should have joint audits and thus again create space for medium-sized firms. They could insist on compulsory retendering or company audits and rotation of auditors. They could invite new players to the audit market. The Securities Exchange Commission or the Financial Services Authority could take charge of audits of banks and financial institutions. None of these proposals are on the radar of the corporate dominated UK accounting regulator, the Financial Reporting Council. It advocates market led solutions, which raises the question of why the markets have not resolved the problems already, and exerted pressures for better audits.

    As a society, we continue to give auditing firms state-guaranteed markets, monopolies, lucrative fees and liability concessions. None of it has given us, or is likely to give us better audits, company accounts, corporate governance or freedom from frauds and fiddles. Without effective independent regulation, public accountability and demanding liability laws, the industry cannot provide value for money.

    Jensen Comment
    You can access a fairly good summary of the Big Four at http://en.wikipedia.org/wiki/Big_Four_auditors

    Bob Jensen's threads on auditing firm scandals and professionalism are at http://www.trinity.edu/rjensen/Fraud001.htm


    2008
    "It's Time to Prepare for the Arrival of International Accounting Standards:  Good Bye (to U.S. GAAP), by Sarah Johnson, CFO Magazine April 1, 2008 --- http://www.cfo.com/article.cfm/10919122/c_10941875?f=magazine_coverstory

    One of the densest thickets of generally accepted accounting principles is revenue recognition. By one tally, more than 160 pieces of authoritative literature relate to how and when companies record revenue. Now, however, U.S. and international accounting authorities are taking a scythe to the rules. They will mow down "broad swaths" of GAAP, says Robert Herz, chairman of the Financial Accounting Standards Board, en route to producing a single set of global accounting guidelines for revenue recognition.

    This slash-and-burn approach is a sign of things to come. For the past five years, FASB and the International Accounting Standards Board (IASB) have been working to merge U.S. accounting rules with international financial reporting standards (IFRS). But this so-called convergence is shaping up to be more of a takeover than a merger of equals — many who favor a single global standard hope to wipe out GAAP altogether.

    Experts at the Big Four accounting firms say a Securities and Exchange Commission mandate for all U.S. publicly traded companies to use IFRS is inevitable. The SEC does plan to release a road map in late spring for transitioning U.S. public companies to the international standards, but it has not yet said whether adopting IFRS will be mandatory. Still, many SEC watchers expect the agency to eventually scrap GAAP.

    "If I'm reading the tea leaves right, it's not a question of if but when," says Jeffrey Keefer, CFO of chemical giant DuPont. Large U.S. companies could start using IFRS instead of GAAP in three years, say accounting firms and finance chiefs, while a mandatory conversion could take effect in five years. Auditors urge CFOs to keep a weather eye on the IFRS movement. "It's going to be bigger than anybody expects," says Gary Illiano, a partner at Grant Thornton. Adds Deloitte & Touche partner Joel Osnoss: "From the smallest public companies to the largest, everyone should at least be thinking about what the potential of this will be."

    Large Benefits Audit firms and multinationals have been pressuring the SEC to keep the global-standards movement on the fast track ever since the end of 2007, when the agency began allowing foreign companies to submit their IFRS-prepared filings without reconciling them to GAAP. That effectively blessed IFRS as high-quality, notes Margaret Smyth, vice president and controller of United Technologies Corp., some of whose international subsidiaries use the global standards. "If it's good enough for the SEC, I would think it's good enough for most people," she says.

    And good enough especially for large multinationals, whose CFOs are tired of using more than one accounting system for regulatory purposes here and abroad. "It's really not cost efficient to maintain two sets of books on different standards," says Richard Fearon, CFO of Cleveland-based Eaton Corp., which has manufacturing sites in 30 countries.

    To eliminate the extra work of adhering to U.S. GAAP as well as to other countries' accounting rules, Fearon would consider using consolidated global accounting rules. But he has reservations. For one, the current form of IFRS is too principles-based for his taste; he would prefer more specificity in the rules, à a la GAAP. Also, he believes the global standards have spawned too many variants among the more than 100 countries that use IFRS-based standards (see Insight, "One Standard, Many Laws").

    Still, Fearon's 2008 agenda includes an investigation into the differences between GAAP and IFRS, particularly how the changes in revenue recognition, taxation, and hedge accounting would affect his balance sheet and income statement. Fearon isn't alone: finance departments at other multinationals, such as PepsiCo and Procter & Gamble, are conducting similar internal studies.

    Continued in article


    2008
    PCAOB Oversight Board Strategic Plan

    Part of an April 28, 2008 message from Roger Debreceny [roger@DEBRECENY.COM]

    The PCAOB has issued its strategic plan for the period from 2008 to 2013 at http://www.pcaob.org/About_the_PCAOB/index.aspx 

    Key takeaways:

    · Use by SEC foreign issues of IFRS impacts work of PCAOB

    · XBRL is on the agenda: “The SEC has taken steps to encourage the implementation of XBRL. As the SEC initiative develops, the PCAOB will have to devote resources to familiarize itself with further XBRL developments and to work closely with the SEC to consider and, as appropriate, establish auditor responsibilities in connection with XBRL-tagged data.”

    · Subprime meltdown: The PCAOB’s risk-based approach enables it to nimbly adapt its programs in response to emerging issues. For example, given the recent subprime crisis, the PCAOB has devoted, and may continue to devote, certain resources to monitor these developments, as well as train staff in this area. In addition, the PCAOB has made certain adjustments to its inspection program to assess subprime-related auditing implications. As the subprime crisis unfolds, related auditing implications may require further adjustments to the PCAOB’s programs, training, and staffing levels.”

    · Globalization: “Given the breadth of the effect of globalization on PCAOB programs, the PCAOB’s strategies related to globalization permeate this Strategic Plan.”

    · Case against legal foundation of PCAOB marches along: “On March 21, 2007, the U.S. District Court for the District of Columbia issued its decision granting summary judgment to the PCAOB in the constitutional lawsuit filed by the Free Enterprise Fund and Beckstead & Watts LLP. On April 13, 2007, plaintiffs filed an appeal to the United States Court of Appeals for the District of Columbia. The continued defense of the lawsuit will likely require significant resources.”

    I have not read every word of the Plan in detail, but what does seem to be missing is a thorough analysis of the standards setting activities of the Board. My perception is that audit standards in the US continue to fall behind the quality of those promulgated by the IAASB. Yet the agenda for new and revised standards from the PCAOB seems modest indeed. There is discussion about the need to work with ASB and IAASB and Goal 1(C) talks in general terms about the need improvement in standards and guidance.

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

    Bob Jensen's timeline of financial scandals and the evolution of accounting standards and the PCAOB are at http://www.trinity.edu/rjensen/FraudCongress.htm

    Bob Jensen's threads on accounting standard setting are at http://www.trinity.edu/rjensen/Theory01.htm


    2008

    I came across this interesting speech by CFTC Commissioner, Bart Chillton. In this speech he gives three loopholes exploited by future market traders - Enron loophole, London loophole and Swaps loophole. Basically all have a similar theme- one market is regulated and other is not and both have near similar products. The regulators can only watch the former and the traders switch and build volumes in the latter. This is actually problematic as because of innovation, one can create similar instruments in another exchange and build up positions (he explains that is what Amaranth traders did). Now what should a regulator do? He says we need more cooperation between regulators.
    Amol Agrawal, Mostly Economics, September 1, 2008 --- http://mostlyeconomics.wordpress.com/


    2008

    "Greater Regulation of Financial Markets?" by Nobel Laureate Gary Becker, The Becker-Posner Blog, April 28, 2008 ---
    http://www.becker-posner-blog.com/

    The major deregulation movement of the past 100 years started with the Ford and Carter administrations in the 1970s, and continued through the Reagan years. This movement came to an end with the passage of the Americans with Disabilities Act of 1990 under the administration of George W. Bush. Since then some sectors, such as labor markets and product safety, have been regulated much more extensively, while others, including commercial and investment banking, have had no further declines in the extent of regulation. Despite the considerable and tangible successes of this deregulation movement, the pressure is intense to significantly increase the regulations affecting consumer safety, the introduction of new drugs, and especially financial markets.

    The 1970s saw a bipartisan reduction in the regulation of airline travel, trucking, security exchanges, and commercial banking. Measures of the success of this deregulation include sharp declines in the cost of air travel and of shipping goods by truck, huge reductions in commissions on stock transactions, and higher interest rates on bank deposits. Not only has no serious attempt been made to re-regulate these activities, but also European and many other nations on all continents have copied the American deregulation of airlines and securities.

    The impetus to tighter regulations varies from sector to sector, although there is a growing belief that many activities are insufficiently regulated. Obviously, the current turmoil in the financial sector is stimulating many proposals to regulate extensively various types of financial transactions. Yet it is not obvious that the problems in the financial sector resulted mainly because of insufficient regulation. For example, commercial banks are probably the most heavily regulated group in the financial sector, yet they are in much greater difficulties than say the hedge fund industry, which is one of the least regulated industries in the financial sector. Banks participated very extensively in originating mortgages, including subprime mortgages, and in buying mortgage-backed securities, and so they are suffering from the high foreclosure rates, and the sharp decline in the market value of these securities.

    One reason why extensive regulation of commercial banks did not prevent many banks from getting into trouble is that bank examiners became optimistic along with banks about the risks associated with mortgages and other bank assets because the market priced these assets as if they carried little risk. It would run counter to human nature for regulators to take a skeptical attitude toward the riskiness of various assets when the market is indicating that these assets are not so risky, and when originating and holding these assets has been quite profitable. One can expect regulators to mainly follow rather than lead the market in assessing riskiness and other asset characteristics.

    To some extent that was also true of the Fed's behavior during the past few years. I believe that Alan Greenspan is right in claiming that the main cause of the housing boom was not the Fed's actions but the worldwide low interest rates due to an abundant world supply of savings. The demand for very durable assets like housing is greatly increased by low interest rates. Still, the Fed seems to have contributed to the booming demand for housing and other assets by keeping the federal funds rate artificially low during the boom years of 2003-05.

    In evaluating the need for greater financial regulation, one should also not forget that the American economy greatly outperformed the European and Japanese economies during the past 25 years. Might that not be related in part to the fact that the United States led the way with major financial innovations like investment banks, hedge funds, futures and derivative markets, and private equity funds that were only lightly regulated? An infrequent period of financial turmoil may be the price that has to be paid for more rapid growth in income and low unemployment. Rapid income and employment growth might be worth an occasional period of turmoil especially if they do not lead to prolonged slowdowns in the real part of the economy. So far the effects on GDP and employment have not been severe, although the financial distress is not yet completely over.

    Nevertheless, a few important regulatory changes are probably warranted. For the first time the Fed allowed investment banks access to its federal funds window, and the Fed guaranteed $29 billion worth of mortgage-backed assets to induce J.P. Morgan to take over that investment company. Since these types of Fed actions would likely be repeated in the event of future financial turmoil, investment banks would have an incentive to take on additional risk since they can reasonably expect to be helped out by the Fed in the future. For this reason it might be desirable for the government to impose upper bounds on the permissible ratios of assets to equity held by investment banks. The ratio of assets to the equity of the five leading investment banks did increase greatly from about 23 in 2004 to the highly leveraged level of 30 in 2007.

    Other regulations of financial institutions may also be merited, but elaborate new regulations of the financial sector would be counterproductive. For example, the Fed has proposed limits on how much mortgage interest rates can exceed the prime rate for low-income borrowers with poor credit ratings. This would be a foolish intervention into the details of credit contracts that have all the defects of usury laws.

    The financial sector has served the economy well by managing, dividing, and pricing different types of risks in the economy. It would be a mistake if Congress and the President allow the present financial turmoil to panic them into inefficient new financial regulations.

    "Greater Regulation of Financial Markets?" by Richard Posner, The Becker-Posner Blog, April 28, 2008 ---
    http://www.becker-posner-blog.com/

    Re-Regulate Financial Markets?--Posner's Comment I no longer believe that deregulation has been a complete, an unqualified, success. As I indicated in my posting of last week, deregulation of the airline industry appears to be a factor in the serious deterioration of service, which I believe has imposed substantial costs on travelers, particularly but not only business travelers; and the partial deregulation of electricity supply may have been a factor in the western energy crisis of 2000 to 2001 and the ensuing Enron debacle. The deregulation of trucking, natural gas, and pipelines has, in contrast, probably been an unqualified success, and likewise the deregulation of the long-distance telecommunications and telecommunications terminal equipment markets, achieved by a combination of deregulatory moves by the Federal Communications Commission beginning in 1968 and the government antitrust suit that culminated in the breakup of AT&T in 1983.

    Although one must be tentative in evaluating current events, I suspect that the deregulation (though again partial) of banking has been a factor in the current credit crisis. The reason is related to Becker's very sensible suggestion that, given the moral hazard created by government bailouts of failing financial institutions, a tighter ceiling should be placed on the risks that banks are permitted to take. Because of federal deposit insurance, banks are able to borrow at low rates and depositors (the lenders) have no incentive to monitor what the banks do with their money. This encourages risk taking that is excessive from an overall social standpoint and was the major factor in the savings and loan collapse of the 1980s. Deregulation, by removing a variety of restrictions on permitted banking activities, has allowed commercial banks to engage in riskier activities than they previously had been allowed to engage in, such as investing in derivatives and in subprime mortgages, and thus deregulation helped to bring on the current credit crunch. At the same time, investment banks such as Bear Sterns have been allowed to engage in what is functionally commercial banking; their lenders do not have deposit insurance--but their lenders are banks that for the reason stated above are happy to make risky loans.

    The Federal Deposit Insurance Reform Act of 2005 required the FDIC to base deposit insurance premiums on an assessment of the riskiness of each banking institution, and last year the Commission issued regulations implementing the statutory directive. But, as far as I can judge, the risk-assessed premiums vary within a very narrow band and are not based on an in-depth assessment of the individual bank’s riskiness.

    Now it is tempting to think that deregulation has nothing to do with this, that the problem is that the banks mistakenly believed that their lending was not risky. I am skeptical. I do not think that bubbles are primarily due to avoidable error. I think they are due to inherent uncertainty about when the bubble will burst. You don't want to sell (or lend, in the case of banks) when the bubble is still growing, because then you may be leaving a lot of money on the table. There were warnings about an impending collapse of housing prices years ago, but anyone who heeded them lost a great deal of money before his ship came in. (Remember how Warren Buffett was criticized in the late 1990s for missing out on the high-tech stock boom.) I suspect that the commercial and investment banks and hedge funds were engaged in rational risk taking, but that (except in the case of the smaller hedge funds--the largest, judging from the bailout of Long-Term Capital Management in 1998, are also considered by federal regulators too large to be permitted to go broke) they took excessive risks because of the moral hazard created by deposit insurance and bailout prospects.

    Perhaps what the savings and loan and now the broader financial-industry crises reveal is the danger of partial deregulation. Full deregulation would entail eliminating both government deposit insurance (especially insurance that is not experience-rated or otherwise proportioned to risk) and bailouts. Partial deregulation can create the worst of all possible worlds, as the western energy crisis may also illustrate, by encouraging firms to take risks secure in the knowledge that the downside risk is truncated.

    There has I think been a tendency of recent Administrations, both Republican and Democratic but especially the former, not to take regulation very seriously. This tendency expresses itself in deep cuts in staff and in the appointment of regulatory administrators who are either political hacks or are ideologically opposed to regulation. (I have long thought it troublesome that Alan Greenspan was a follower of Ayn Rand.) This would be fine if zero regulation were the social desideratum, but it is not. The correct approach is to carve down regulation to the optimal level but then finance and staff and enforce the remaining regulatory duties competently and in good faith. Judging by the number of scandals in recent years involving the regulation of health, safety, and the environment, this is not being done. And to these examples should probably be added the weak regulation of questionable mortgage practices and of rating agencies' conflicts of interest and, more basically, a failure to appreciate the gravity of the moral hazard problem in the financial industry.


    Bob Jensen's threads on Credit Derivative and Credit Risk Swap --- http://www.trinity.edu/rjensen/acct5341/speakers/133glosf.htm#C-Terms
    Scroll down to "Credit Derivative and Credit Risk Swap."


    2008
    Unlike many other nations that either did not have national accounting standards or had weak and incomplete sets of standards, the FASB over the years produced the best set of accounting standards in the world (although there is no such thing a perfect set since companies are always writing contracts to circumvent most any standard). The FASB standards were heavily rule-based due to the continual battles fought by the FASB in the trenches of U.S. firms seeking to manage earnings and keep debt of the balance sheet with ever-increasing contract complexities such as interest rate swaps invented in the 1980s, SPE ploys, securitization "sales," synthetic leasing, etc.
                         

    • The experiences of those frazzled executives in charge of reducing risks in the credit derivatives market are starting to resemble Alice’s adventures in Wonderland. Alice shrank after drinking a potion, but was then too small to reach the key to open the door. The cake she ate did make her grow, but far too much. It was not until she found a mushroom that allowed her to both grow and shrink that she was able to adjust to the right size, and enter the beautiful garden. It took an awfully long time, with quite a number of unpleasant experiences, to get there.
      Aline van Duyn, "The adventure never ends in the derivatives Wonderland," Financial Times, September 11, 2008 --- Click Here

       
    • While Lehman Brothers was fighting for its life in the markets today, it was also battling in a Senate panel's hearing on whether the company and others created a set of financial products whose primary purpose is to dodge taxes owned on U.S. stock dividends. The "most compelling" reason for entering into dividend-related stock swaps are the tax savings, Highbridge Capital Management Treasury and Finance Director Richard Potapchuk told the Senate's Permanent Subcommittee on Investigations. Lehman Brothers (nyse: LEH - news - people ), Morgan Stanley (nyse: MS - news - people ) and Deutsche Bank (nyse: DB - news - people ) are among the companies behind the products.
      Anitia Raghaven, The Tax Dodge Derivative, Forbes, September 11, 2008 --- Click Here
       

       

    • What's Right and What's Wrong With (SPEs), SPVs, and VIEs ---
                            http://www.trinity.edu/rjensen//theory/00overview/speOverview.htm

    2008
    "Taking liberties (and tax dollars)," by Prem Sekka, The Guardian, September 15, 2008 --- http://www.guardian.co.uk/commentisfree/2008/sep/15/creditcrunch.taxandspending

    Financial institutions are teetering and are relying on the taxpayer to bail them out. Fannie Mae and Freddie Mac have effectively been nationalised at a possible cost of $200bn (£111.3bn) or more. A soft loan of $29bn persuaded JP Morgan to buy Bear Stearns. Lehman Brothers has filed for bankruptcy. Merrill Lynch has been swallowed by Bank of America. Commercial banks are borrowing around $19bn a day from the US Treasury's emergency lending programme to keep them afloat and new rescue funding is being created. Northern Rock has been bailed out by the UK taxpayer. The Bank of England has provided around £200bn of emergency funding to support financial institutions. The European Central Bank has lent banks some €467bn (£378bn) as it tries to deal with chaos manufactured in corporate boardrooms.

    Banks are expecting taxpayers to save them from the consequences of poor financial decisions. Yet at the same time, behind a veil of secrecy, they have been eroding tax revenues by designing and marketing tax-avoidance schemes.

    A recent investigation by the US Senate permanent subcommittee on investigations found that major financial institutions have "devised complex financial structures to enable their offshore clients to dodge US dividend taxes". The offshore dodges are estimated to cost the US Treasury around $100bn a year in lost tax revenues. The Senate subcommittee highlighted the use of stock swaps and stock lending transactions to avoid taxes on dividends paid by US companies. Its report focuses on transactions devised and carried out by Lehman Brothers, Morgan Stanley, Deutsche Bank, UBS, Merrill Lynch and Citigroup.

    The data available to the subcommittee – page 8 of the