Enron Updates on March 25, 2002
Bob Jensen at Trinity University

Bob Jensen's main document on the Enron scandal and other accounting frauds is at http://www.trinity.edu/rjensen/fraud.htm 

The sudden collapse of Enron has prompted investors to demand greater transparency, and companies are responding by expanding their annual reports. Every company has its own unique disclosure challenges, but corporate giants General Electric and IBM are clearly at the forefront when it comes to complexity. These same companies are also clearly raising the bar when it comes to voluntary corporate reporting. http://www.accountingweb.com/item/74828 

Perhaps this is one of the first steps toward allowing investors to view financial databases.

From The Wall Street Journal Accounting Educators' Review on March 14, 2002

TITLE: GE's Annual Report Bulges With Data In Bid to Address Post-Enron Concerns 
REPORTER: Rachel Emma Silverman 
DATE: Mar 11, 2002 
PAGE: A3 LINK: http://online.wsj.com/article/0,,SB1015622451989914320.djm,00.html  
TOPICS: Advanced Financial Accounting, Consolidation, Accounting, Disclosure, Disclosure Requirements, Financial Accounting, Financial Statement Analysis, Regulation

SUMMARY: General Electric Co. issued a 93-page 2001 annual report containing more details about its operations than the annual reports issued by GE in previous years. Some argue that the increased reporting by GE may set a new standard for financial reporting.

QUESTIONS: 
1.) List three things that are different about GE's 2001 annual report. Why did GE choose to make these changes? Are the additional disclosures made by GE required under Generally Accepted Accounting Principles? Support your answer.

2.) List three advantages and three disadvantages of increasing the quantity of disclosure contained in annual reports. Should companies be required to disclose more information? Support your answer.

3.) Who are the primary users of information contained in annual reports? Discuss the ability of these users to process detailed financial statement information.

4.) What is the role of financial analysts in financial reporting? Do financial analysts face any conflicts of interest when interpreting financial results? Does providing more information in financial reports improve the quality of information available to unsophisticated investors? Support your answer.

SMALL GROUP ASSIGNMENT: If you support increased disclosure requirements by Generally Accepted Accounting Principles, propose three standards that would require increased disclosure. How would your proposed standards increase the usefulness of financial reporting?

If you do not support increased disclosure requirements by Generally Accepted Accounting Principles, defend existing standards.

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

Bob Jensen's threads on proposed accountancy profession reforms in the wake of the Enron scandal are at http://www.trinity.edu/rjensen/FraudProposedReforms.htm

The U.S. Department of Justice on Thursday announced that a federal grand jury has indicted Big Five firm Andersen on charges of obstruction of regulatory and criminal proceedings as a result of document destruction relating to the audit of Enron Corporation. http://www.accountingweb.com/item/75137 

Roger Collins informed me about this Financial Times article.

A global reputation falls apart Andersen's fall from grace shows that companies are judged on what they do, not what they say their values are, says Peter Martin, Financial Times, March 18 2002 --- http://news.ft.com/ft/gx.cgi/ftc?pagename=View&c=Article&cid=FT37MQHQYYC&live=true 

Shakespeare was right. Andersen's continuing implosion shows that once reputation is lost, the immortal essence of a business goes too: the goodwill that it can pass on to the next generation, the ties that bind colleagues together, the intangible virtues of its good name.

What remains is, if not bestial, then certainly all too human: the scramble for self-protection, the emergence of regional rivalries, the triumph of sauve-qui-peut.

Accountants are watching Andersen's struggles with astonishment and fear. Although they have always known how important reputation was to their business, the speed with which the firm has started to unravel has taken everyone by surprise.

Some of the lessons of the Andersen story are specific to the audit business. Others are of general relevance to professional service firms and indeed to any business built on human capital and a global network of knowledge workers.

Of the many lessons, I have selected five:

* Bad judgment will hurt you but a cover-up is lethal. Andersen has admitted mistakes in its audits of Enron and the quality of its work has been criticised by US regulators in three other instances. If that were the firm's only problem, it would not be in such a desperate situation today. The haemorrhage of clients would have been at manageable levels and there would be enough time to negotiate a sale to the best bidder.

What has left the firm scrambling to find a future is not the original audit errors but the perceived cover-up, the shredding of documents and the destruction of e-mails.

Even if Andersen's Houston office was doing no more than ensuring - as other accounting firms also do - that the permanent record of its audit was uncluttered by hypothetical questions or internal debate, the shredding looks bad. The fact that it occurred after the well publicised launch of an informal investigation by the Securities and Exchange Commission is also hard to defend.

Shredding is easy to explain to a grand jury in pursuit of a criminal indictment; the consolidation test for special purpose entities is not.

So the first lesson of the Andersen case, one that applies to every type of business, is: avoid any perception of a cover-up. Do not permit, and above all do not encourage, any sort of destruction of records once an investigation is getting under way, no matter how tentative it is.

* Your values are what you are willing to enforce. I owe this insight to David Maister, author of Managing the Professional Service Firm*. It is all very well, he says, drawing up carefully crafted value statements and ethics codes. All professional services firms do. They are often meaningless.

What count are the non-negotiable minimum standards that the firm is prepared to fire people over. This is not a piece of moralism, simply a commercial issue.

If, as the Andersen indictment** alleges, "the Andersen team handling the Enron audit directly contravened the accounting methodology approved by Andersen's own specialists working in its Professional Standards Group", that is a clear indication of what Andersen's head office was and was not prepared to enforce - and thus what its ultimate values were.

* Rethink the professional services business model. This is another Maister point. Cross-selling between audit and non-audit parts of accounting firms has always produced much less business than is commonly believed, he says.

Yet accountants continued to defend the practice, even though audit was the least profitable part of the business. Maister's solution is that accountants should spin off their audit arms and keep their consulting business - the reverse of the commonly accepted wisdom.

You do not have to accept that logic to see that the concept of a professional services supermarket is inherently vulnerable to reputational damage and probably less fruitful than its defenders suggest.

Whatever its strengths or weaknesses, it will probably not survive the Andersen case. Which leaves big accounting, consulting and law firms - all of whom have bet their futures on this vision - scrambling to find a new strategy.

* Human capital can walk. Andersen's undignified scramble to survive over the past few days has been made much harder by the fact that its principal asset (other than its now tarnished name) resides in the heads of its employees.

When a manufacturing company is threatened by scandal, its employees cannot simply walk off with the machinery. But an accounting firm - or an advertising agency, or a consultancy - does not really own the intellectual capital on which it runs.

In spite of all the talk of knowledge as a corporate asset, it remains firmly in the possession of individuals. And they can negotiate alternative futures for themselves that may not match up with those designed at head office.

* The network is the business. This is the offsetting factor that prevents Andersen simply splitting up into its constituent national elements.

Big company audits require global reach and a common set of standards and practices. Today's global Andersen possesses these; potential national successor firms do not. Individual groups of partners can certainly find employment elsewhere - but on terms that reflect merely their own skills, not their value as members of a collaborating network.

The network issue arises in a particularly strong form at Andersen. Its legal problems arose in the US, the most important global economy and one on which Andersen was particularly dependent for historical reasons. Without the US firm, the value of Andersen's network is seriously weakened.

So the rest of the firm could not simply slough off the US partnership and continue without it - as it might have been able to do if the issue had arisen in any other country. This made a future independent existence unlikely.

Big businesses increasingly owe their value to their status as global networks. The Andersen experience is relevant well beyond the borders of the professional services firm.

FedEx, Riggs Bank, Household International, and Kerr-McGee added their names this week to the long and growing list of former Andersen audit clients who are opting to purchase their audit services from other accounting firms. For those of you who are trying to keep score, here are the defections and the winning other Big Five CPA firms who have gained Andersen's clients. http://www.accountingweb.com/item/74745 

Differences of opinion between House Democrats and Republicans have resulted in the introduction of a second bill in the House Financial Services Committee. Known as the Comprehensive Investor Protection Act, this new proposal is the toughest accounting reform bill yet. It was the result of close coordination with the Securities and Exchange Commission, and it is supported by the AFL-CIO, consumer groups, and former SEC Chief Accountant Lynn Turner. http://www.accountingweb.com/item/73861 

Differences of opinion between House Democrats and Republicans have resulted in the introduction of a second bill in the House Financial Services Committee. Known as the Comprehensive Investor Protection Act (CIPA), this new proposal is the toughest accounting reform bill yet. It was the result of close coordination with the Securities and Exchange Commission (SEC), and it is supported by the AFL-CIO, consumer groups, and former SEC Chief Accountant Lynn Turner.

Among other things, CIPA would:

• Create a Public Accountability Board with a 7-member majority selected from the public and the remaining 6 members drawn from groups representing institutional investors and pension funds.
  
• Empower the Board to conduct reviews of audits and audit firms, institute disciplinary actions and set standards for quality control of audits, auditor independence, and ethics.
  
• Impose tougher legal penalties on auditors by restoring joint and several liability in certain circumstances and restoring the aiding and abetting liability for accountants and outside professionals.
  
• Require the SEC to review more filings more systematically based on a risk-rating system that uses analytics (such as price-earnings ratios) to determine the frequency of reviews.
  
• Restrict auditors from providing a list of specified nonaudit services and require audit committee approval of any nonaudit services not listed in the bill, such as tax services.
  
• Require a 4-year rotation of auditors, with the possibility of one 4-year extension, if approved by the Public Accounting Regulatory Board.
  
• Require audit committees to meet quarterly with auditors and have an opportunity to do so outside the presence of management.
  
• Require a 2-year cooling off period for certain former auditor employees before they could work for an audit client.
  
• Prohibit directors from providing consulting services to the companies on whose boards they sit.
  
• Double the resources for SEC’s Division of Enforcement, Corporation Finance, and Office of the Chief Accountant.
  
• Set restrictions on security analysts to prevent conflicts of interest.

In introducing the bill, Representative John LaFalce said, the reforms are not "cosmetic" and do not "paper over the problem." Georgetown University law professor Donald Langevoort told Reuters, "If it were just the little guy who got trounced [by the Enron collapse], we would simply get cosmetic changes. But this has hurt more than the little guy."

Read the news release. Read the summary of the bill. View a side-by-side comparison with the bill introduced by the House Financial Services Committee Republicans.

The American Institute of CPAs is building a lobbying campaign against Enron-related reform proposals being discussed in Washington and demanded by the private sector. According to an AICPA spokesman, an e-mail was distributed to 3,000 federal key people - AICPA members who have contact and/or access to lawmakers - urging their assistance in convincing lawmakers to temper the response to requests for reforms. http://www.accountingweb.com/item/74169

The lobbying coalition of accountants formed by the American Institute of Certified Public Accountants and the Big Five firms is short one firm today as the group has voted to sever ties with Andersen for the time being. The group, which typically presents a united front when lobbying for issues before Congress, has agreed to let Andersen fight its own battles for now. http://www.accountingweb.com/item/73994 

Also see http://www.house.gov/banking_democrats/pr_020228.htm 

President George Bush has introduced a ten-point plan to improve corporate responsibility and protect America's shareholders. For the most part, the plan endorses reforms already suggested by the Securities and Exchange Commission. Reactions to the plan were mixed. http://www.accountingweb.com/item/74564 

Barry C. Melancon, president and CEO of the American Institute of CPAs, was a key witness at the March 13 hearing on the Corporate and Auditing Accountability, Responsibility, and Transparency Act of 2002 (CARTA). CARTA proposes relatively modest changes compared with other bills, and it is believed to be the bill most supported by the accounting profession. http://www.accountingweb.com/item/74940 

On March 1, 2002 in the wake of the Enron scandal and FASB hearings, the FASB wrote a summary report of SPE accounting at http://www.fei.org/download/FASB_SPE.pdf 

Often these structures are used to finance specific assets or a revolving asset base transferred to the SPE. The transfer of trade receivables, loans, or investment securities to the SPE would generally be followed by the SPE’s issuance of debt to investors secured by the transferred assets. The borrower/transferor gains access to a source of funds less expensive than would otherwise be available. This advantage derives from isolating the assets in an entity prohibited from undertaking any other business activity or taking on any additional debt, thereby creating a better security interest in the assets for the lender/investor. SPE financing structures issue many forms of asset-backed securities, including collateralized bond, debt, and loan obligations; and trade receivable commercial paper conduits.

An SPE might be the lessor of a property built for the specific needs of an identified lessee, such as a power plant or a production facility. These transactions are often referred to as synthetic leases and provide tax-advantaged financing lower than traditional mortgage loans. Another form of tax-advantaged SPE transaction is the sale to an SPE of an asset that qualifies as a financing under tax regulations, with any gain on sale deferred for tax purposes. These are known as debt-for-tax transactions.

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

Response of the Andersen accounting firm to Harvey Pitt's proposed Oversight Board
I thank Dennis Beresford for the tip on the document below.

This response is from the Andersen document at  http://www.andersen.com/website.nsf/content/MediaCenterIOBfirstreport!OpenDocument&Email=True

Independent Oversight Board — Report I

March 11, 2002

This report describes the first decisions reached by the Independent Oversight Board with respect to the basic structure, policies and practices of Arthur Andersen LLP and related organizations.

Taken as a whole, the Board believes these decisions can provide a framework for assuring the priority, the independence and the integrity of the Andersen auditing practice. It believes the conclusions are consistent with the responsibilities of the profession to the investing public.

Taken together, the decisions with respect to internal practices and policies and the structure of the Andersen partnerships are designed to recognize and enhance the basic responsibility of the auditing profession in general and of Andersen in particular to its clients and to the investing public. The efficient allocation of capital and the integrity of financial markets rests in substantial part on uniform, reliable and clear financial reporting, consistent with generally accepted accounting principles and attested to by independent experts.

In making its decisions, the Board has given great weight to the need, in conducting audits, to avoiding the reality or appearance of conflicts of interest that might otherwise arise in firms offering a variety of services. It also recognizes that effective auditing of financial statements requires strong professional discipline, effective training in the complexities of modern finance, and clear recognition of the need for timely, accurate and comprehensive reports to the investing community.

There have been lapses in achieving these goals in this country and elsewhere. The difficulties are not confined to Andersen, or to auditing firms, alone. Matters of corporate governance, of regulation and other professional responsibilities surely deserve attention. But it is the hope and conviction of the Oversight Board that the policies and practices set out for Arthur Andersen LLP and related entities could, when implemented, enable that firm to play a leading role in a profession strongly responsible to the public interest.

Structural organization The Independent Oversight Board outlines a new structure for Andersen LLP and related partnerships that will clearly recognize the priority of protecting the independence of the auditing function:

Specifically:

1. Consulting with respect to substantial Information and Communication Technology (ICT), strategic planning, the practice of law, organized executive recruitment, and certain areas of “aggressive” tax planning and advocacy unrelated to auditing should be separated into partnerships managed independently from auditing partners and without financial interdependence.

[Explanatory note: In Europe and most other areas, these consulting functions are already carried out in legally separate partnerships. In the U.S., these functions have been performed within Andersen LLP. Consequently, Andersen LLP will need to be reorganized to achieve the separation.]

2. The individually organized national auditing partnerships can maintain international contractual linkages among themselves.

3. Similarly, the national consulting partnerships will be free to maintain international linkages.

4. For a transitional period, a common service company may be established to maintain needed computer and other existing technical support functions and to assist in the orderly termination of the existing contractual relationship among some 100 existing Andersen-related partnerships.

5. As this reorganization is completed, there will be no partner interlocks, no revenue or profit-sharing, and no cross-subsidies between the “auditing” and “consulting” partnerships.

Auditing discipline The Oversight Board believes certain clear organizational principles need to be firmly established within Arthur Andersen LLP and related auditing partnerships:

1. A strong expert analytic and technical group of senior partners must have central and unambiguous authority over new and difficult interpretations of accepted accounting standards.

2. In making these determinations, the emphasis should be placed on respecting the clear intent of the standard.

3. Engagement partners and regional managers should refer difficult or ambiguous questions to the central group for its resolution.

4. A designated group of senior partners should have authority to resolve issues of client solicitation and retention, with clear documentation of decisions.

5. Engagement partners should be rotated at intervals of no more than five years.

6. Emphasis in compensation of auditing partners and staff should be placed on effective auditing, management and training performance and skills, and should not provide incentives for solicitation and marketing of non-audit related services.

7. Partners should respect a suitable “cooling off” period before seeking or accepting employment with an audit client.

8. To encourage cohesiveness, coordination and clear lines of responsibility, the senior managing partners should be encouraged to maintain their offices at a central location.

9. A continuing public review body, succeeding the present Independent Oversight Board, should be established with responsibility for at least annual review of the quality and independence of audits.

Audit-related services Certain services closely and traditionally connected with the auditing practices of public companies can reasonably be maintained consistent with the desired priority to, and independence of, the auditing function. The provision of certain of these services to an audit client should be dependent upon the clear and considered agreement of the directors and particularly the audit committee of the client company. Partner and partnership remuneration practices should be comparable to that of the audit practice, without “contingency” or “success” fees.

1. Tax preparation, record keeping and compliance, including review of tax policies that may affect the integrity of the financial reports.

2. “Due diligence” in contemplation of mergers or acquisitions or other purchases.

3. Valuation of assets and auditing of employee benefits to the extent permitted by regulation.

Other services should be confined to non-audit clients:

1. Outsourcing of internal auditing and accounting work.

2. Executive client tax and accounting services.

3. Limited ICT design and implementation for small and medium-sized business.

These changes, which are intended to supplement existing regulation, will necessarily take time to implement in an orderly manner. The Oversight Board, with the assistance of its Advisory Panel, intends to review the process, as well as determine further steps that may be necessary.

One implication of the approach set forth is that client companies, their directors and audit committees, and their top management must recognize their interest in quality auditing provided without potentially conflicting interests. They must be willing to provide appropriate compensation for quality and independent audits.

The Oversight Board also recognizes that success in the entire effort will rest on the talent, commitment and strong sense of integrity by the partners and staff of the entire Andersen organization. That organization has had a proud heritage of superior technical competence and leadership. The Oversight Board looks forward to the restoration of that leadership

Bob Jensen's threads on proposed accountancy profession reforms in the wake of the Enron scandal are at http://www.trinity.edu/rjensen/FraudProposedReforms.htm 

Hi Roger,

What perfect timing. I leave for Denver tomorrow to be on a presentation panel with Steve Zeff. Thank you so much for this lead.

Bob Jensen

-----Original Message----- 
From: Roger Collins [mailto:rcollins@cariboo.bc.ca]  
Sent: Thursday, March 07, 2002 3:42 PM 
To: Robert Jensen 
Subject: FT.com | TotalSearch | Global Archive | Article

Bob, this is a bit old - but it contains comments from Steve Zeff and Baruch Lev; also, an attempt to contrast what might have happened under UK rules (what they don't mention is that there is another line of defense in the UK for folks bent on misfeasance - namely, much stricter libel laws than in the U.S.)

http://globalarchive.ft.com/globalarchive/article.html?id=020117001942&query=Enron+and+FASB 

Roger

Roger Collins Associate Professor UCC School of Business

Beleaguered Andersen was dealt another blow Wednesday when mortgage giant Freddie Mac dropped the Big Five firm after a 30- year audit relationship. Freddie Mac joins a long and growing list of clients that are abandoning Andersen in the aftermath of the firm's involvement in the Enron collapse. http://www.accountingweb.com/item/74260 

A Message from Lisa Young on March 4, 2002

A message from Ernst & Young to members of the Accounting Faculty:

Since our last communication regarding events in the