Accounting Scandal Updates on March 31, 2003
Bob Jensen at Trinity University

 

Updates and issues in the accounting, finance, and business scandals --- http://www.trinity.edu/rjensen/fraud.htm 

Many of the scandals are documented at http://www.trinity.edu/rjensen/fraud.htm 

Andersen audits got "behind!"
Sure seemed enough,
When Waste Management audits ignored smelly stuff.

And Andersen's unveilings bottomed out,
When Victoria Secret audits turned into doubt.

Now the latest criminal  issue,
Is Andersen's clean wipe of American Tissue.

AccountingWEB US - Mar-12-2003 - In yet another black mark against the now-defunct accounting firm of Arthur Andersen, LLP, a former senior auditor of the firm has been arrested in connection with the audit of American Tissue, the nation's fourth-largest tissue maker. Brendon McDonald, formerly of Andersen's Melville, NY office, surrendered Monday at the United States Courthouse in Central Islip, NY. He could face as much as 10 years in prison for his role in allegedly destroying documents related to the American Tissue audits.

Mr. McDonald is accused of deleting e-mail messages, shredding documents, and aiding the officers of American Tissue in defrauding lenders of as much as $300 million. American Tissue's chief executive officer and other executives were also arrested and charged with various counts of securities and bank fraud and conspiracy.

According to court documents, American Tissue inflated income and diverted money to subsidiaries in an attempt to make the company eligible to borrow additional money. "The paper trail of phony sales transactions, bogus supporting documentation and numerous accounting irregularities ended quite literally with the destruction of the falsified documents by American Tissue's auditor," said Kevin P. Donovan, an assistant director of the Federal Bureau of Investigation, according to a statement that appeared in The New York Times ("Paper Company Officials Charged," March 11, 2003).

 

The European Commission on Monday rejected a plea from the "Big Four" accounting firms for a monetary limit on the amount that auditors can be sued for. Frits Bolkestein, European commissioner responsible for financial services, said unlimited liability was a "quality driver" because auditors who did their job properly had no exposure to litigation.
Andrew Parker, The New York Times, March 24, 2003

Chronicling the inner workings of Andersen at the height of its success, Toffler reveals "the making of an Android," the peculiar process of employee indoctrination into the Andersen culture; how Androids - both accountants and consultants--lived the mantra "keep the client happy"; and how internal infighting and "billing your brains out" rather than quality work became the all-important goals. Final Accounting should be required reading in every business school, beginning with the dean and the faculty that set the tone and culture." - Paul Volker, former Chairman of the Federal Reserve Board.
The AccountingWeb, March 25, 2003.
Details about this book and other references are listed at http://www.trinity.edu/rjensen/fraud.htm#References 

The SEC wants the AICPA to know, in no uncertain terms, who's in charge of standard setting. Following the release last week of an AICPA exposure draft on internal control reporting, the SEC expressed strong concerns that the AICPA is creating the perception that they are more involved in the standard setting process than they really are. http://www.accountingweb.com/item/97327 

Mark Morze has the dubious distinction of having perpetrated one of the biggest and most brazen financial frauds in American history, serving as "president" of ZZZZ Best's insurance restoration business. Mr. Morze, who spent over four years in prison and is now helping auditors discover fraud, shares over 30 questions that the auditors should have asked that would have stopped him dead in his tracks. http://www.accountingweb.com/item/97336 

The latest Enron Scandal book in the words of the lead whistle blower herself:
Power Failure: The Inside Story of the Collapse of Enron
by Mimi Swartz, Sherron Watkins
See http://www.trinity.edu/rjensen/fraud.htm#References 

New
Fraudulent Dealer Tricks:  An Interactive DHTML Illustration ---  http://www.trinity.edu/rjensen/FraudDealerTricks.htm 
This includes a summary of ten unethical tricks of the trade by automobile dealers.

Free Whistle Blower Hotlines from TeleSentry (all hours seven days per week) --- http://telesentry.org/hotline.htm 

We have designed our toll free reporting service specifically to provide employees an anonymous communication channel to bring forth Code of Conduct concerns and establish a protected platform for on-going communications with your company.

Bob Jensen's tips on how to report fraud --- http://www.trinity.edu/rjensen/fraud.htm#ThingsToKnow 

Big Four accounting firm KPMG has agreed to pay $125 million as a result of a class action lawsuit filed by shareholders of Rite Aid, the nation's third-largest drugstore chain. In addition, KPMG has agreed to pay $75 million to shareholders of Oxford Health Plans after a computer snafu at Oxford in 1977 resulted in collection and payment delinquencies. http://www.accountingweb.com/item/97269 

Other selected KPMG scandals are summarized at http://www.trinity.edu/rjensen/fraud.htm#KPMG 

WorldCom, the long-distance carrier that is mired in the nation's largest bankruptcy filing, said yesterday that it was writing down $79.8 billion of its good will and other assets. The move is an acknowledgment that many areas of the company's vast telecommunications network are essentially worthless. The company said in a statement that all existing good will, valued at $45 billion, would be written down. WorldCom also said it would reduce the value of $44.8 billion of equipment and other intangible assets to about $10 billion. WorldCom had previously signaled that it was considering the write-downs, but the immensity of the values involved surprised some analysts. WorldCom's write-downs are second only to those of AOL Time Warner, which recently wrote down nearly $100 billion of assets.
Simon Romero (See Below)

HealthSouth and Ernst & Young

Scrushy Accounting:  Sarbanes-Oxley's First Significant Test

Nonetheless, Mr. Smith and HealthSouth's chief executive, Richard Scrushy, on two occasions last year swore in public filings that the company's financial statements fairly presented HealthSouth's financial condition and operating results. Those quarterly certifications, which the Sarbanes-Oxley Act began requiring last year, appear to have made it much easier for prosecutors to build their case against Mr. Smith. The SEC filed civil charges against Mr. Scrushy Wednesday, but he hasn't been charged criminally. Prosecutors referred to HealthSouth's CEO and other unnamed HealthSouth senior executives as co-conspirators throughout Wednesday's court filings. Neither Mr. Scrushy nor his lawyer could be reached for comment.
Jonathon Weil

To Follow:  Another Billion Dollar Lawsuit Against Ernst & Young
"Prosecutors Outline Practices Behind HealthSouth Charges,: by Jonathan Weil, The Wall Street Journal, March 20, 2003, Page C1 --- http://online.wsj.com/article/0,,SB104813028448850400,00.html?mod=todays%5Fus%5Fmoneyfront%5Fhs 

Forget about Enron-like special-purpose entities or exotic-sounding financial engineering. The accounting fraud to which HealthSouth's former chief financial officer, Weston L. Smith, agreed to plead guilty in an Alabama federal court was as straightforward as accounting fraud gets. Yet, because it was so well hidden, according to prosecutors, outside investors barely stood a chance of detecting it.

Here is how the health-care provider's scheme worked, according to prosecutors. Intent on not missing Wall Street analysts' earnings estimates, HealthSouth Corp. executives made a series of adjustments that manipulated the company's revenue line so revenue and earnings would appear larger than they were.

The executives made the adjustments to certain allowances on HealthSouth's financial statements. The allowances accounted for the difference between what HealthSouth charged a patient and the amount the company could collect from the patient's health insurer. By lowering the allowances improperly, HealthSouth improved its net revenue and bottom-line earnings.

At HealthSouth, for every dollar of illicit revenue that company executives recorded, they also had to make a corresponding entry on the company's balance sheet. And if they plowed it all into one type of asset, the company's auditors at Ernst & Young LLP's Birmingham, Ala., office -- where Mr. Smith had been an auditor during the 1980s -- might detect it. So they spread the improper entries far and wide in tiny pieces across HealthSouth's balance sheet.

According to the government, HealthSouth executives plumped such things as the company's inventory and intangible assets and property, plant and equipment assets. They even overstated the company's cash by $300 million, according to prosecutors. The improper entries, some of which dated to 1997, eventually piled up. HealthSouth's deft handling of its balance sheet made it practically impossible for investors to detect the scheme before it was too late. (HealthSouth has said it is cooperating with the Justice Department's criminal investigation.)

"The predominant evidence is not that the rules don't work," says Sean Coffey, a partner at New York law firm Bernstein Litowitz Berger & Grossman who specializes in pursuing class-action securities-fraud lawsuits. "It's that people continue to break the rules, and the gatekeepers keep letting them get away with it. There were rules that prohibited just about everything this guy did, and he just did it anyway."

The charges facing Mr. Smith include filing a false certification statement with the Securities and Exchange Commission, a violation of new laws established by last year's Sarbanes-Oxley securities legislation aimed at improving corporate governance. Mr. Smith's case underscores how Sarbanes-Oxley won't stop fraudulent earnings management, though it likely will result in more criminal prosecutions for accounting fraud.

The parts of the financial statements that Mr. Smith -- and, allegedly, other HealthSouth executives -- exploited, for the most part, are areas where management has broad discretion to estimate asset values. As long as corporate managers are the ones determining those values, opportunities for abuse will abound. In any given period, small irregularities that look like normal variances often can go undetected.

By mid-2002, according to prosecutors, HealthSouth's total assets were overstated by $1.5 billion. Property, plant and equipment assets were overstated by $1 billion, or more than 50%, and earnings for the first six months of 2002 were inflated by more than $150 million, the Justice Department said.

Nonetheless, Mr. Smith and HealthSouth's chief executive, Richard Scrushy, on two occasions last year swore in public filings that the company's financial statements fairly presented HealthSouth's financial condition and operating results. Those quarterly certifications, which the Sarbanes-Oxley Act began requiring last year, appear to have made it much easier for prosecutors to build their case against Mr. Smith. The SEC filed civil charges against Mr. Scrushy Wednesday, but he hasn't been charged criminally. Prosecutors referred to HealthSouth's CEO and other unnamed HealthSouth senior executives as co-conspirators throughout Wednesday's court filings. Neither Mr. Scrushy nor his lawyer could be reached for comment.

Continued in the article.

The SEC link --- http://www.sec.gov/litigation/litreleases/lr18044.htm 

Securities and Exchange Commission

Litigation Release No. 18044 / March 20, 2003

Accounting and Auditing Enforcement
Release No. 1744 / March 20, 2003

SEC Charges HealthSouth Corp., CEO Richard Scrushy
With $1.4 Billion Accounting Fraud

Commission Action Seeks Injunction, Money Penalties, Officer and Director Bar

Commission Obtains Emergency Relief

Securities and Exchange Commission v. HealthSouth Corporation and Richard M. Scrushy, CV-03-J-0615-S (N.D. Ala.)

The Securities and Exchange Commission announced that on March 19, 2003, it filed accounting fraud charges in federal district court in the Northern District of Alabama against HealthSouth Corporation ("HRC"), the nation's largest provider of outpatient surgery, diagnostic and rehabilitative healthcare services, and its Chief Executive Officer and Chairman Richard M. Scrushy.

The Commission's complaint alleges that since 1999, at the insistence of Scrushy, HRC systematically overstated its earnings by at least $1.4 billion in order to meet or exceed Wall Street earnings expectations. The false increases in earnings were matched by false increases in HRC's assets. By the third quarter of 2002, HRC's assets were overstated by at least $800 million, or approximately 10 percent. The complaint further alleges that, following the Commission's order last year requiring executive officers of major public companies to certify the accuracy and completeness of their companies' financial statements, Scrushy certified HRC's financial statements when he knew or was reckless in not knowing they were materially false and misleading.

According to the complaint:

The Commission alleges that HRC's and Scrushy's actions violated and/or aided and abetted violations of the antifraud, reporting, books-and-records, and internal controls provisions of the federal securities laws. Specifically, the Commission has charged HRC with violating Section 17(a) of the Securities Act and Sections 10(b), 13(a), 13(b)(2)(A) and 13(b)(2)(B) of the Exchange Act, and Exchange Act Rules 10b-5, 12b-20, 13a-1, and 13a-13. The Commission has charged Scrushy with violating Section 17(a) of the Securities Act and Sections 10(b) and 13(b)(5) of the Exchange Act, and Exchange Act Rules 10b-5 and 13b2-1. The Commission also has charged Scrushy with aiding and abetting HRC's violations of Sections 13(a), 13(b)(2)(A), and 13(b)(2)(B) of the Exchange Act and Exchange Act Rules 12b-20, 13a-1, and 13a-13.

For these violations, the Commission is seeking a permanent injunction against HRC and Scrushy, civil money penalties from both defendants, disgorgement of all ill-gotten gains and losses avoided by both defendants as a result of the conduct alleged plus prejudgment interest thereon. The Commission also is seeking an order (i) prohibiting Scrushy from serving as an officer or director of a public company, (ii) freezing the assets of Scrushy, (iii) requiring HRC to escrow in an interest-bearing account, all extraordinary payments (including compensation) to any director, officer, partner, controlling person, agent, or employee, and (iv) preserving HRC's documents.

The Commission also obtained emergency relief on March 19, 2003 against HRC and Scrushy in the District Court. HealthSouth consented to the entry of an order by the Court (1) requiring that the company place in escrow, under the Court's supervision, all extraordinary payments (whether compensation or otherwise) to its directors, officers, partners, controlling persons, agents, or employees, pursuant to the provisions of the Sarbanes-Oxley Act of 2002, (2) prohibiting the company and its employees from destroying documents relating to the company's financial activities and/or the allegations in the Commission's case against HealthSouth in Scrushy, and (3) providing for expedited discovery in the Commission's case. The Court also entered a temporary order freezing substantially all of Scrushy's assets.

Pursuant to a separate Commission order issued on March 19, 2003, trading in the securities of HRC was suspended for two business days due to the materially misleading information in the marketplace.

The Commission wishes to thank the U.S. Attorney's Office for the Northern District of Alabama, the U.S. Department of Justice, and the Federal Bureau of Investigation for their cooperation in this matter.

The Commission's investigation is continuing.

SEC Complaint in this matter

Audit committees are supposed to be a big deal in fraud prevention . . . or are they a sham?  Enron's audit committee proved to be a useless pawn of Enron managers.  The big issue at HealthSouth centers on if the Audit Committee met and if it did anything.  

 

The case of the slippery Michael Young and the tight-lipped  Ernst & Young.  
The SEC has commenced litigation claiming over $1 billion in fraud undetected by the HealthSouth Audit Committee and the external auditors.
"HealthSouth Audit Panel Met Three Times in '01? ... Maybe," by Johathan Weil, The Wall Street Journal, March 25, 2003 --- http://online.wsj.com/article/0,,SB104855430955864400-search,00.html?collection=wsjie%2F30day&vql_string=HealthSouth%3Cin%3E%28article%2Dbody%29 

Call it the case of the missing HealthSouth Corp. audit-committee meetings.

HealthSouth's 2002 proxy statement clearly states that the company's audit committee met only once in 2001. Within days of the government's accounting-fraud accusations against the company and its top officers, critics seized on the disclosure as a sign that the committee was asleep at the switch.

But now an attorney for the HealthSouth board's audit committee, Michael Young of the law firm Willkie Farr & Gallagher, says newly uncovered information shows the committee was not (asleep).

The proxy statement, he says, got it wrong. Just how wrong is the subject of conflicting accounts, both provided at different times by Mr. Young.

On Friday night, in response to an article in The Wall Street Journal that day citing the proxy, Mr. Young called a Journal reporter to say the audit committee had met "at least five times" in 2001, based on newly found records, copies of which he declined to provide. (See related article.)

Before the article's publication, HealthSouth audit committee members and company spokesmen hadn't returned calls seeking comment, and a spokesman for HealthSouth's auditor, Ernst & Young LLP, had declined to comment on the audit committee's activities.

For a Reuters article published Sunday night, Mr. Young told a reporter that the audit committee had met at least three times, citing records from Ernst & Young and the committee's chairman. Mr. Young Monday said the lower tally is the best available information. An Ernst spokesman Monday said the accounting firm's records show Ernst auditors attended three HealthSouth audit-committee meetings in 2001. The three audit-committee members are George H. Strong, C. Sage Givens and Larry D. Striplin Jr. An assistant to Mr. Striplin said he wouldn't comment, while the other two members couldn't be reached.

Some critics remain skeptical. "A proxy statement is an official document," says Columbia University accounting professor Itzhak Sharav, adding that HealthSouth should file an amended proxy if the committee met more than once in 2001. "A statement over the phone carries very little weight with me." Asked if an amended proxy would be filed, Mr. Young says: "I have no idea. There are more pressing issues than amending a proxy statement with regard to the number of audit-committee meetings in 2001."

A HealthSouth spokesman Monday said he couldn't confirm how many times the committee met, and had no immediate comment on whether the company would file an amended proxy statement.

The Securities and Exchange Commission recommends audit committees meet at least four times a year. Ideally, former SEC Chairman Arthur Levitt said in a 1998 speech, an audit committee would meet 12 times a year.

Ernst & Young's purported failure to protect its HealtSouth client from insider fraud is another instance supporting the following assertion by Mark Morze (instigator of the ZZZZ Best well-know fraud):

Mark Morze has the dubious distinction of having perpetrated one of the biggest and most brazen financial frauds in American history, serving as "president" of ZZZZ Best's insurance restoration business. Mr. Morze, who spent over four years in prison and is now helping auditors discover fraud, shares over 30 questions that the auditors should have asked that would have stopped him dead in his tracks. http://www.accountingweb.com/item/97336 

Is this smoke and mirrors or what?
Deloitte and Touche is Considering Getting Out of the Auditing Business

AccountingWEB US - Mar-20-2003 - These are confusing times for accountants. As the accounting profession jockeys to identify and secure its proper place in the financial universe, conflicting messages continue to emanate from the leaders of the profession. 

Paul Volcker Calls For an End to High End Tax Work

In an interview this week with the Financial Times, former Fed Chairman Paul Volcker called upon the Public Company Accounting Oversight Board to ban audit firms from performing tax work for audit clients. "You can run into a real conflict if the auditor has to audit the tax planning of the company," said Mr. Volcker.

Mr. Volcker, who at this time last year was advocating that the ailing Andersen accounting firm become the model "audit-only" firm, still feels strongly that audit firms should back away from corporate finance, legal and tax services and focus on one core audit service, without any independence conflicts.

Deloitte Chief Contemplates Getting Out of the Audit Business

Deloitte Touche Tohmatsu chairman Piet Hoogendoorn warned over the weekend that exposure to lawsuits was forcing global accountancy firms to consider abandoning statutory audit work.

Our Dutch sister site AccountingWEB.nl reported that in his role as chairman of the Netherlands professional body NIVRA, Hoogendoorn voiced his concerns in an interview with the 'Het Financieele Dagblad' newspaper.

The big global firms were thinking about quitting the audit market because of the difficulty of getting professional indemnity cover. Insurers who were willing or able to provide cover could be counted on the fingers of one hand, he said.

Although Mr. Hoogendoorn's comments may be more politically motivated due to concerns stirred up over Dutch retailer Ahold's financial misrepresentations, it nevertheless represents a shot across the bow as to how audit reforms will be played out in the future, and whether there is a viable business model left for accounting firms to pursue.

Arthur Levitt to CFOs: Show Some Backbone

At his latest stop in a speaking tour to financial professionals, former SEC Chairman Arthur Levitt told a group of CFO's this week to "set the standard" and "provide moral and ethical leadership. Bring a dose of reality to your hard-charging CEOs." He implored the audience to resist the "culture of seduction" to fudge the numbers in favor of personal gain, and to let investors really know how a company is doing, without bending to Wall Street's expectations.

In his crusade to help restore investor confidence, Arthur Levitt's message to America's CFO's is clear: Do The Right Thing.

And The Last Word From Investment guru Warren Buffett

Warren Buffett's eagerly awaited Annual Letter to Shareholders released this week has some unique insight on corporate governance, financial reporting, and auditor responsibilities. Here's a sneak preview on Mr. Buffett's insight on curbing CEO compensation:

"The acid test for reform will be CEO compensation. Managers will cheerfully agree to board 'diversity,' attest to SEC filings and adopt meaningless proposals relating to process. What many will fight, however, is a hard look at their own pay and perks. In recent years compensation committees too often have been tail-wagging puppy dogs meekly following recommendations by consultants, a breed not known for allegiance to the faceless shareholders who pay their fees."

Get a more complete look at the words and wisdom of Warren Buffett. --- 

Mr. Buffett's annual Letter to Shareholders, in which he shares his views on his company and the state of corporate America --- http://www.berkshirehathaway.com/letters/2002pdf.pdf 

 

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