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

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:

• Shortly after HRC became publicly traded in 1986, and at Scrushy's instruction, the company began to artificially inflate its earnings to match Wall Street analysts' expectations and maintain the market price for HRC's stock. Between 1999 and the second quarter of 2002, HRC intentionally overstated its earnings, identified as "Income Before Income Taxes And Minority Interests," by at least $1.4 billion in reports filed with the Commission. HRC also overstated earnings, identified as "Income Before Income Taxes And Minority Interests," in the quarterly reports on Form 10-Q filed with the Commission during these years.
   
• Pursuant to the scheme, on a quarterly basis, HRC's senior officers would present Scrushy with an analysis of HRC's actual, but as yet unreported, earnings for the quarter as compared to Wall Street's expected earnings for the company. If HRC's actual results fell short of expectations, Scrushy would tell HRC's management to "fix it" by recording false earnings on HRC's accounting records to make up the shortfall.
   
• HRC's senior accounting personnel then convened a meeting to "fix" the earnings shortfall. At these meetings, HRC's senior accounting personnel discussed what false accounting entries could be made and recorded to inflate reported earnings to match Wall Street analysts' expectations. These entries primarily consisted of reducing a contra revenue account, called "contractual adjustment," and/or decreasing expenses, (either of which increased earnings), and correspondingly increasing assets or decreasing liabilities.
   
• Scrushy has personally profited from the scheme to artificially inflate earnings. He has sold at least 7,782,130 shares of HRC stock since 1999, when HRC's share price was affected by HRC's artificially inflated earnings. Moreover, Scrushy received salary and bonus payments based on HRC's artificially inflated earnings.
   
• In mid-2002, certain HRC senior officers and Scrushy discussed the impact of the scheme to inflate earnings because they were concerned about the consequences of the August 14, 2002 financial statement certification required under Commission Order No. 4-460, Order Requiring the Filing of Sworn Statements Pursuant to Section 21(a)(1) of the Securities Exchange Act of 1934 (June 27, 2002). ("Order 4-460").
   
• Scrushy knew or was reckless in not knowing that HRC's financial statements materially overstated its operating results. Nevertheless, on August 14, 2002, he and HRC's Chief Financial Officer certified under oath that HRC's 2001 Form 10-K contained no "untrue statement of material fact." In truth, the financial statements filed with this report overstated HRC's earnings, identified as "Income Before Income Taxes And Minority Interests" on HRC's income statement, by at least 4,700 %.

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 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.

The Commission acknowledges the assistance provided by the staff of the Federal Energy Regulatory Commission in this investigation.

The Commission also acknowledges the continuing coordination among the Division of Enforcement, the Justice Department Enron Task Force and the Federal Bureau of Investigation in the Enron investigation.

The Commission's investigation is continuing. For additional information see

• SEC v. Andrew S. Fastow - Litigation Release 17762 (Oct. 2, 2002)
   
• SEC v. Michael J. Kopper — Litigation Release 17692 (Aug. 21, 2002)
   
• SEC v. Kevin A. Howard and Michael W. Krautz — Litigation Release 18030 (March 12, 2003)

SEC Complaint in this matter

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

Especially note the "Rotten to the Core" section at http://www.trinity.edu/rjensen/fraud.htm#Cleland 

The Biggest Crime of All:  They Still Don't Get It

"A Buffett Warning on Executive Pay," by Bloombert News, The New York Times, March 17, 2003 

Warren E. Buffett, the billionaire investor, says that companies will not regain investors' trust as long as compensation for chief executives, including stock options, keeps rising while the share prices of their companies fall. "What really gets the public is when C.E.O.'s get very rich and stay very rich and they get very poor," Mr. Buffett told chief executives at a conference on corporate governance on Friday night in Charlotte, N.C. Mr. Buffett's views on responsibilities of executives and directors have gained new prominence after accounting scandals at WorldCom and Enron, the two biggest bankruptcies, shook investors' confidence and costs stockholders billions of dollars. Regulators and executives, including Bank of America's former chief executive, Hugh L. McColl Jr., who helped arrange the meeting, have sought advice from Mr. Buffett on topics like executive pay and corporate governance. Mr. Buffett, 72, the largest shareholder in Coca-Cola and American Express, was paid $356,400 in 2001 as chief executive of Berkshire Hathaway, his investment company based in Omaha. "It is vital that we earn back the trust of the American public," Mr. Buffett said. "We will get it back when we deserve it. When I start reading the proxy statements a year from now, I'll know whether American businessmen and businesswomen are serious about wanting to really give back to the system what the system has given to them."

"Wall Streets CEOs Still Get Fat Paychecks Despite Woes," by Susanne Craig, The Wall Street Journal, March 3, 2003

Chiefs' Packages Decline Overall Still, $10 Million or More Isn't Bad

Stock markets are down. Corporate public offerings are out. Investors are on the sidelines. And financial firms continue to cut staff.

 But there is still a bull market in one pocket of Wall Street -- the pay of securities-firm CEOs.

Amid one of the worst operating environments in years, Wall Street chief executives continue to pull down annual paychecks topping $10 million. Even though their pay is down overall, it is still turning heads in many quarters. Morgan Stanley's CEO Philip Purcell received a 2002 pay package of $11 million. Goldman Sachs Group Inc.'s Henry Paulson made $12.1 million and Lehman Brothers Holdings Inc.'s Richard Fuld took home a pay package valued at $12.5 million.

 

Citigroup Inc.'s Chief Executive Sanford I. Weill, whose banking firm has been dogged by regulatory probes this year, volunteered not to receive a cash or stock bonus for 2002 because the share price of the company, which owns Salomon Smith Barney, dropped 25% during the year.

But Citigroup's board granted Mr. Weill stock options for 2003 with an current estimated value of $17.9 million, more than the $17 million cash bonus Mr. Weill received in 2001. At Bear Stearns Cos., one of the few securities firms that actually saw its profit rise in 2002, CEO James Cayne saw his total compensation more than double to $19.6 million last year.

 

The still-hefty paychecks are drawing criticism as being out of whack with these tough economic times. On Wall Street, fees from the most profitable businesses -- such merger-and-acquisition advice and underwriting initial public offerings of stock -- have all but dried up.

"The problem is there is no strong indication the bear market is over and we are a long way from justifying these type of packages," says Mike Corasaniti, director of research at boutique investment firm Keefe, Bruyette & Woods Inc. and an adjunct professor in the business department of  Columbia University in New York .

 

"In good times boards justify the big pay packages by saying the executives are doing a great job and in bad times they justify the pay by saying they are managing in a difficult environment. No matter what, they seem to find a way to rationalize it."

Officials at the various firms declined to comment

Of course, a Wall Street CEO's pay is tied to performance. And the job hasn't been easy. But the tough decision to cut staff may have in fact boosted the pay packages of many top executives, as the cost-cutting measures kicked in. With the exception of a few firms, notably Credit Suisse Group's Credit Suisse First Boston, most Wall Street firms have actually been making money during the bear market. CSFB reported a loss for 2002 of $811 million, due to $813 million in charges to cover items ranging from 1,500 previously announced job cuts to a provision for civil-litigation costs.

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

Also see http://www.trinity.edu/rjensen/fraudVirginia.htm  

Also see the exhobitant compensation of the new executive team at Adelphia (see below)

I cannot say that I buy into Todd Boyle's reply below, but he does raise food for thought. In the end, however, I do think that the war issue really is about weapons of mass destruction. If Saddam gave up those weapons tomorrow there would be no war. 
March 8, 2003 reply from Todd Boyle [tboyle@rosehill.net]

Hi Bob,

Needless to say, some of that money goes into bribes and kickbacks to members of the boards and hiring committees, and other influencers. Would $100,000 in an envelope, impress some people? Yes, and more often it is some bizarre transaction way down in the business process.

That could all be reduced if banking transparency were increased; instead your faithful representatives in Congress work to strengthen banking secrecy, calling it "privacy". The little guy, in America, couldn't care less about financial privacy of course. That has been one of the surprising findings that came out of the dotcom era, as well as earlier experiments in encryption, private messaging, etc. Nobody would pay an extra cent for any of them.

Since American citizen doesn't natively, care about privacy, BANKS need to teach us a lesson, to get us on the same side of the issue with wealthy plutocrats. So we're all being abused with 10 or 20 years of banking frauds, called "identity theft".

1. banks maintain insecure card and ATM infrastructures, 2. the banking system suffers fraud and having a government protected monopoly on settlement and holding of deposits, simply ploughs the loss back onto the depositor or merchant, 3. the banking system then conspires to block the credit of the account-holder for months, who has done nothing wrong, and 4. they publish 120 decibel press releases calling the depositor the "Victim" and screaming for better privacy and financial secrecy.

This gets better.

The Iraq war could have been avoided years ago if banks simply cooperated in enforcing UN resolutions. Instead, suppliers of arms, machine parts, tools, etc. in Europe and former soviet states, easily broke the blockade and enabled Saddam Hussein to continue operating his military infrastructure.

The very foundation of American prosperity is welcoming immigrants with all their money, and selling them land etc. America is built on a foundation of accepting deposits from the whole planet on a good-faith basis ---- do you recall for example, brief experiments imposing withholding taxes on bank interest? After the banks bled white from capital flight the global investors won, and to this day there's no withholding tax on qualifying bank bond interest paid to foreigners.

And after all THIS global money recycling (dating back to recycling of Petro-dollars of the 1970s, Eurodollars in the 1960s and before, is the very system we are fighting to protect in the middle east: It is NOTHING LESS than the global financial and legal framework for multinational corporations, i.e., the integrity and nonrepudiation of accounts.

The Iraq invasion is not for oil, itself! Good god no. The oil will always come to market regardless whether it is drilled by rednecks or towel-heads. Nor is it about secret germ labs, or other fantastic excuses Bush talks about.

We are bombing to protect the western framework for banking and financial governance. That, is what CPAs are bound to defend. The sanctity and eternal righteousness of our infinite, interlocking, consolidated ziggurat of corporate general ledgers and their bank reconciliations.

It is time for a "freedom of information act" addressing excessive secrecy and lack of accountability of corporations. http://www.gldialtone.com/FinancialDeregulation.htm 

Todd

A federal grand jury indicted former U.S. Technologies Inc. Chief Executive C. Gregory Earls, charging him with misappropriating more than $15 million from investors --- http://online.wsj.com/article/0,,SB104854297214257100,00.html?mod=technology_main_whats_news 

From The Wall Street Journal Accounting Educators' Review on March 28, 2003

TITLE: Sarbanes-Oxley Begins to Take Hold 
REPORTER: Janet Whitman 
DATE: Mar 25, 2003 
PAGE: C9
LINK: http://online.wsj.com/article/0,,SB104854620916355400,00.html  
TOPICS: Accounting, Accounting Law, Auditing, Sarbanes-Oxley Act

SUMMARY: PricewaterhouseCoopers surveyed 137 chief financial officers and managing directors to obtain their views on the Sarbanes-Oxley Act. Results of the survey are reported in the article.

QUESTIONS: 
1.) According to the article, what was the primary purpose of the Sarbanes-Oxley Act? Do the executives surveyed believe that the Act will achieve its intended purpose? Support your answer.

2.) What is reported as being the primary benefits of the Act? Do these benefits do anything to restore investor confidence? Support your answer.

3.) List three provisions of the Sarbanes-Oxley Act that you believe will do the most to restore investor confidence in financial reporting. Support your answers.

4.) What percentage of the respondents report significant changes as a result of the Sarbanes-Oxley Act? If the survey results are accurate, was the Act needed? Support your answer.

5.) Reconcile the following survey results. "About 42% said that, though it is a well meaning attempt, the law will impose unnecessary costs on companies." "Only 4% cited substantial changes."

6.) How many respondents believe that more needs to be done to improve financial reporting and restore investor confidence? List three additional measures that should be taken.

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

This is a good site!
AICPA Antifraud & Corporate Responsibility Resource Center --- http://www.aicpa.org/antifraud/ 

FASB Project Schedules --- http://www.fasb.org/project/index.shtml 

From KPMG:  Revisiting Stock-Option Accounting --- http://www.fei.org/download/KPMGMarch03_6.pdf 
Bob Jensen's threads on this issue are at http://www.trinity.edu/rjensen/theory/sfas123/jensen01.htm 

I might remind Rolf Eden that Al Capone and many other famous men were killed from syphilis that did not come from sitting on a public toilet seat.  See Example 10 below.

"Harvey Pitt's Misstep Among "Dumbest Moments in Business," SmartPros --- http://www.smartpros.com/x37480.xml 

SAN FRANCISCO, Mar. 18, 2003 — Spotlighting humorous corporate follies and executive missteps from the past year, the April 2003 issue of Business 2.0 features the magazine's newest list of the "101 Dumbest Moments in Business."

Former Securities and Exchange Commission chief Harvey Pitt received special mention due to his botched attempt to appoint William Webster as head of the new Public Company Acccounting Oversight Board. Webster's potential "credibility problem" as a board member of U.S. Technologies was ignored by Pitt, and he appointed Webster anyway. This proved to be the last straw for the White House and led to Pitt's resignation in November 2002

A case of questionable compensation practices is also included on the list. Kmart's appointment of James Adamson as its turnaround specialist and chief executive led to 30,000 layoffs within 10 months -- and the eventual resignation of the "turnaround specialist." Regardless, Adamson is set to receive a $3.6 million bonus once Kmart is out of Chapter 11. The company lost about $2 billion under Adamson's watch, but Adamson's total take will amount to $7 million.

Separately, Kmart's most marketable product and personality, Martha Stewart, had her own fire to put out this past year. The home decorating guru is under investigation for insider trading of ImClone stock.

Beyond the scandals surrounding Pitt, Kmart, and Stewart, the special report, released by Business 2.0, a product of The FORTUNE Group at Time Inc., also highlights lesser-known but equally remarkable business flubs from a variety of sources. The following are 10 of the top corporate blunders from Business 2.0's third annual list of the "101 Dumbest Moments in Business":

1. Midas launches an ad campaign featuring an elderly woman ripping open her blouse, asking what the company's lifetime "tune-up" guarantee can do for her body.

2. Yahoo ends up paying an undisclosed sum to Wylie Gustafson, the yodeler featured in its ads, after he sues the company for $5 million, claiming he was paid only for limited use.

3. Hop-On sends samples of its new, innovative disposable cell phone to reporters, who quickly discover that the phone's "revolutionary secret" is actually run-of-the-mill Nokia parts.

4. Clonaid tries to sell a mysterious $9,220 contraption called the RMX 2010, heightening the product's ambiguity by donating one to a British science museum with strict orders not to open it to find out what is inside.

5. Microsoft's senior vice president for Windows, Brian Valentine, declares at a conference that all operating systems suck.

6. In an effort to stanch his company's bleeding, Edison School CEO Chris Whittle suggests putting Edison students to work for an hour a day -- for free.

7. Barclay Knapp, CEO of telecommunications firm NTL, proclaims that he built a good company -- just one with a bad balance sheet -- shortly before filing for bankruptcy with debts totaling nearly $23.4 billion.

8. Employees at a floundering car plant in Romania propose to erase the company's $20 million debt by selling their sperm.

9. The National Cattlemen's Beef Association launches a marketing website designed to "steer" girls away from vegetarianism.

10. German real estate tycoon Rolf Eden offers to pay 125,000 euros to any woman who can kill him through sexual intercourse.

Lucent admitted it had incorrectly accounted for $679 million in revenue in its fiscal 2000 fourth quarter.

The auditing firm is PricewaterhouseCoopers (PwC)

Lucent Settles Shareholder Suits In Agreement Worth $568 Million," by Dennis K. Berman, The Wall Street Journal, March 30, 2003 --- http://online.wsj.com/article/0,,SB104880537423229200,00.html?mod=technology_main_whats_news 

Lucent Technologies Inc. said Thursday night that it had settled massive shareholder litigation for a total of $568 million in cash, stock and warrants, in one of the largest such settlements in history.

The size of the settlement shows the amount of risk that Lucent, one of the country's most widely held stocks, faced from at least 54 shareowner lawsuits. People involved in the case said that the Murray Hill, N.J., company faced a potential bankruptcy situation if it had gone to trial and lost.

The settlement also shows that Lucent is trying to put its woes behind it. Just last month, the company settled a civil case with the Securities and Exchange Commission without admitting or denying any wrongdoing, though Lucent vowed not to violate securities laws in the future. The SEC had been investigating Lucent's sales practices for over two years. "The clouds have been put behind us," said Kathleen Fitzgerald, Lucent's spokeswoman.

The main thrust of the shareholder suits claimed that the large telecommunications-maker engaged in financial fraud and aggressive sales practices to sustain its growth during the height of the telecom boom, from the time of its fourth-quarter 1999 financial results until December 2000. Then, Lucent admitted it had incorrectly accounted for $679 million in revenue in its fiscal 2000 fourth quarter.

The settlement will pay the estimated five million holders of Lucent stock between Oct. 26, 1999, and Dec. 21, 2000, a mix of both cash and stock totaling $315 million. According to the company, it will have discretion to issue these shareholders either stock or cash.

Lucent said its insurers agreed to pay another $148 million in cash, and Lucent also will issue 200 million stock warrants to shareowners, with a strike price of $2.75 and a three-year expiration. The company estimates the current value of those warrants at $100 million. The company said it would contribute another $5 million for administration of the claims process. While the company hopes to recover some of its portion of the settlement from insurers, Lucent said it expects to take a charge in the second quarter of $420 million, or 11 cents a share.

Attorneys for the plaintiffs, led by New York firm Milberg Weiss Bershad Hynes & Lerach LLP, also will collect a sizable amount for their work in the case. Partner David Bershad said the attorneys expect to seek fees of as much as 20% of the total settlement, and the attorneys would take the same proportion of cash, stock and warrants that shareholders get. That would mean fees of as much as $115 million. Both the settlement and the attorneys' fees require court approval.

Mr. Bershad said in an interview Thursday night that he believed the plaintiffs' cases posed "a serious threat" to Lucent.

Continued in the article.

Bob Jensen's threads on revenue accounting are at http://www.trinity.edu/rjensen/ecommerce/eitf01.htm 

"AICPA Reviews Specialties, Reassures Credential Holders," AccountingWeb, February 27, 2003 --- http://www.accountingweb.com/cgi-bin/item.cgi?id=97209 

AccountingWEB US - Feb-27-2003 -  The American Institute of Certified Public Accountants announced last week its plan to evaluate the future of the organization's specialty credentials to determine if they should be strengthened, redesigned, remain status quo, or discontinued.

Accreditations being reviewed include the Accredited in Business Valuation (ABV) credential, the Certified Information Technology Professional (CITP), and the Personal Financial Planning Specialist (PFS).

Credential holders received a letter from Bruce Harper, AICPA's National Accreditation Commission (NAC) chairman, who indicated the NAC plans to analyze the allocation of resources to the CPA credential versus the specialty credentials and to assess the market competitiveness of the specialty credentials. One option being explored is whether each of the various specialty credentials would be better served under the umbrella of other related organizations.

Specialty credential holders reacted hotly to the news. "They are killing the PFS and the CITP because they cost too much money," said a source quoted in Bowman's Accounting Report.

"We are not abandoning them," AICPA board member Harold Monk said. "We are trying to see if we can attrition them into other organizations or continue to make them work in some way. They are terribly expensive to support."

Meanwhile, the AICPA responded with a promise this week to continue supporting any member who holds a specialty designation, regardless of the future of the credentials.

Speculation abounds that the CITP and PFS credentials will no longer be offered by the AICPA but that the organization will continue to build the ABV credential. It is important to note that all the facts are not yet in on this issue, and the question of financially supporting the credentials is just at the assessment stage.

The issue of the ongoing viability of supporting the various specialty designations will be addressed and debated at the AICPA Spring Council meeting April 27-30, 2003.

After my move to the White Mountains on June 10, the only cable TV service available is from Adelphia.  Now I will be able to get those "adult channels."  But at my age, what's the use?

May 3, 2003 message from FinanceProfessor [FinanceProfessor@lb.bcentral.com] 

Well after a few months of relative quiet, Adelphia sure has been in the news a great deal of late. If you do not remember, Adelphia was the US’s sixth largest cable provider and was headquarter in nearby Coudersport PA. Then due to what most see as fraud and self-serving behavior of the Rigases, the firm was forced into bankruptcy and delisted. The Rigases were the first of the big names to be arrested by Federal authorities when the elder John Rigas was taken away in handcuffs.

So just a quick update of what has happened recently.

They have hired a new executive team to what many (including former CEO John Rigas) claim is an exorbitant contract, they are moving their headquarters from Coudersport PA to Denver Colorado, they ended their long term ban on “adult” channels, and they began charging significantly higher rates (over a 100% increase in many cases) to their commercial users.

And as amazing as it sounds, it seems like all of the accounting problems are not yet over! The company just admitted they would have to restate their 2002 earnings after certain expenses were classified as capital expenditures.

http://www.forbes.com/home_europe/newswire/2003/02/27/rtr893110.html 

http://biz.yahoo.com/rf/030220/media_adelphia_2.html

Last week Adelphia announced a new controversial pay package for the new executives. The pay plan, which calls for $26 million to the new CEO Michel William Schleyer and $16 million for the new COO Ronald Cooper, has been called excessive by many shareholders, including the Rigases themselves. The new execs both come from ATT’s Broadband unit. Since the firm is in bankruptcy the pay plan must be approved by the bankruptcy judge. The new CEO is saying that if the pay plan is cut, he may not leave the firm. (personally I doubt it, but maybe). The plan as structured has a $7.6 “severance package” (platinum parachute, which pays him $7.6 million if Schleyer is removed from either his CEO or Chairman of the board positions for any reason! Schleyer is threatening to not take the job if the pay is reduced, but I think I would call his bluff. http://www.buffalonews.com/editorial/20030227/1019818.asp

http://abcnews.go.com/wire/Business/reuters20030224_689.html

http://biz.yahoo.com/rf/030220/media_adelphia_2.html

Adelphia is moving their corporate headquarters to Denver in a move that will likely hurt Coudersport PA quite bad. http://www.insidedenver.com/drmn/business/article/0,1299,DRMN_4_1759879,00.html

The sale of the Sabres appears to more likely as Thomas Golisano appears have gotten approval to buy the team which has played poorly this year. Stay tuned. http://sportsnetwork.com/default.asp?c=sportsnetwork&page=nhl/news/ADN2467143.htm

From the AccountingWeb on March 4, 2003 --- http://www.accountingweb.com/cgi-bin/item.cgi?id=97235 

AccountingWEB US - Mar-4-2003 -  The trend of suing accounting firms continues, this time in Switzerland. Aided by the results of a year-long study performed by PricewaterhouseCoopers, the Swiss state of Geneva has demanded 3 billion Swiss francs (US$2.2 billion) from Big Four firm Ernst & Young for damages from audits stemming from 1994 to the present.

According to the PwC report, E&Y used a method of risk evaluation that was "outside legal norms" when issuing statements concerning the merger of audit client Banque Cantonale de Geneve with another bank.

Continued in the article.

From the AccountingWeb on March 4, 2003 --- http://www.accountingweb.com/cgi-bin/item.cgi?id=97250 

AccountingWEB US - Mar-6-2003 -  Last week VTech Holdings Ltd filed a $400 million lawsuit against PricewaterhouseCoopers (PwC) stemming from VTech’s acquisition of a business unit of Lucent Technologies in 2000. VTech alleges that PwC concealed information about the unit’s financial condition.

According to the suit, filed in a Manhattan federal court, PricewaterhouseCoopers allegedly convinced VTech to pay $113.3 million for the Lucent unit in order to impress its "bigger paying client." PwC was acting as an advisor for Lucent at the time of the transaction.

"We see no basis for any lawsuit against us," said Steven Silber, a spokesperson for PwC.

VTech, a Hong Kong-based company, designs, manufactures, markets and sells electronic learning and telecommunication products. It paid $113 million for the consumer telephone assets of Lucent, an AT&T spin-off. The acquisition doubled VTech’s consumer telecommunications business and gave it an exclusive 10-year right to use the AT&T brand name in the U.S. and Canada.

Continued in the article.

"Europe's Year of Nasty Surprises:  Suddenly, the Continent is awash in accounting scandals," Business Week, March 10, 2002 --- http://www.businessweek.com/magazine/content/03_10/b3823071_mz014.htm 

In a global downturn, Royal Ahold (AHO ) should have been the ultimate defensive play. The 116-year-old Dutch company is the world's third-largest food retailer, with supermarket chains including Albert Heijn in Europe and Giant and Stop & Shop in the U.S. But on Feb. 24, Ahold sent European markets tumbling when it admitted overstating earnings at subsidiaries in the U.S. and Argentina by at least $500 million in 2001 and 2002. Chief Executive Officer Cees van der Hoeven resigned along with his chief financial officer, and bond-rating agencies downgraded Ahold to junk status. "We're furious. We never expected anything like this: [We] trusted their long-term strategy," fumes a top executive at a major European financial group that is a big Ahold investor. His shares lost 60% of their value the day of the Ahold disclosures. 

From The Wall Street Journal Accounting Educators' Review on February 28, 2003

TITLE: Supermarket Firm Ahold Faces U.S. Inquiries 
REPORTER: ANITA RAGHAVAN, ALMAR LATOUR and MICHAEL SCHROEDER 
DATE: Feb 26, 2003 
PAGE: A2 
LINK: http://online.wsj.com/article/0,,SB1046206345249379943,00.html  
TOPICS: Accounting, Accounting Fraud, Accounting Irregularities, Audit Quality, Executive compensation, Fraudulent Financial Reporting, Securities and Exchange Commission

SUMMARY: Ahold, the third largest food retailer in the world, announced that profits for 2001 and 2002 were overstated by at least $500 million dollars. The Securities and Exchange Commission is investigating and has requested working papers from Ahold's auditor, Deloitte & Touche.

QUESTIONS: 
1.) Refer to the first related article. Describe the accounting issue that led to the overstatement in profits on Ahold's financial statements. According to U.S. Generally Accepted Accounting Principles, when should revenue be recognized? Should rebates and bonuses received from food makers follow this general principle? Support your answer.

2.) Since Ahold is a Dutch company, why are they being investigated by the Securities and Exchange Commission in the United States? Refer to the second related article. Discuss the issues that relate to non-U.S. accounting firms that audit companies listed in the U.S. Is Ahold required to report financial statements prepared in accordance with U.S. GAAP? Support your answer.

3.) Discuss the impact of bonuses paid for meeting growth targets on incentives to manipulate accounting profits.

4.) The main article states, "the probes center on whether fraud was involved in the improper accounting . . . " What is fraud? If the improper accounting is not the result of fraud, what other explanation for it exists?

5.) The SEC has asked Deloitte & Touche for workpapers related to its audit of Ahold. Under what conditions can an auditor share details of workpapers?

--- RELATED ARTICLES ---
 TITLE: Payments to Distributors Draw Scrutiny, Fleming Now Faces a Formal Probe 
REPORTER: ANN ZIMMERMAN and PATRICIA CALLAHAN 
PAGE: A2
 ISSUE: Feb 26, 2003 
LINK: http://online.wsj.com/article/0,,SB1046211799861970103,00.html 

TITLE: Ahold Case May Damp Exemption For Foreign Accountants by SEC 
REPORTER: JONATHAN WEIL 
PAGE: A2
 ISSUE: Feb 26, 2003 
LINK: http://online.wsj.com/article/0,,SB1046212486893126583,00.html 

 Bob Jensen's threads on revenue reporting can be found at http://www.trinity.edu/rjensen/ecommerce/eitf01

Related Links:

http://www.washingtonpost.com/wp-dyn/articles/A57863-2003Feb24.html

http://www.thestreet.com/_tsclsii/markets/stockwatch/10070318.html

http://www.nytimes.com/2003/02/27/business/worldbusiness/27GROC.html

http://news.bbc.co.uk/1/hi/business/2797097.stm

http://www.washingtonpost.com/wp-dyn/articles/A30409-2003Mar2.html

http://biz.yahoo.com/djus/030301/1600000053_1.html

Leading tax software companies Intuit (TurboTax) and H&R Block (TaxCut) may be producing software that puts customer tax data at risk, according to some data security experts. Both TurboTax and TaxCut leave taxpayer data files unencrypted and thus unprotected from hackers, and some people are concerned about the possibility of identity theft. http://www.accountingweb.com/item/97277 

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

MasterCard, Visa, American Express and the banks that issue credit cards don't do enough to protect merchants and consumers from the perils of fraud, reports analyst firm Gartner --- http://www.wired.com/news/privacy/0,1848,57823,00.html 

The credit card industry focuses too much on reducing its own fraud costs and not enough on protecting consumers.

That's the central claim in a new report from research firm Gartner that slams credit card companies for failing to notify consumers when credit card records are compromised by malicious hackers.

The report notes that while credit card companies' "zero-liability" policies protect card holders from paying for unauthorized or fraudulent charges, they do not protect consumers from identity theft and the credit report hell that can follow.

Avivah Litan, Gartner vice president and the report's co-author, said when security breaches happen, banks that issue credit cards seldom notify consumers.

"The issuers claim they don't really know if a card was compromised after a merchant or transaction processing firm reports a problem, so they wait to see whether a consumer reports fraud against his or her card," Litan said.

"Of course the fact that closing potentially compromised accounts and providing consumers with new cards costs the issuer about $35 per card is also a factor here. So the card issuers take a calculated risk that compromised cards won't be used fraudulently."

On Feb. 18, Visa, MasterCard and American Express confirmed that a malicious hacker had gotten access to 8 million credit card records through Data Processors International, a company that processes credit card transactions for mail order and online businesses.

The credit card companies quickly issued statements saying none of the stolen card-holder information was used fraudulently, and that all card-issuing banks had been alerted to the problem.

According to Litan, the card issuers have tagged the accounts believed to have been compromised in the theft, and will watch them for a period of time, typically three to six months, for possible fraudulent use.

"Based on a standard margin of error, I wouldn't be surprised to see 5 percent of those stolen cards compromised even while they are on the watch list," Litan said. "The only way to ensure that the cards will never be fraudulently used is to issue new cards to all 8 million users."

Consumer rights groups agreed that credit card companies should notify card holders about potential problems, and should at least offer the option of replacement cards if account records have been illegally accessed.

"Credit card issuers and other creditors should be required to let customers know immediately if they believe that their account information has been compromised," said Susan Grant, director of the National Fraud Information Center. "As it is now, it's hard for consumers to know exactly how security breaches happen or assess whether the companies who have their information have taken adequate steps to safeguard it."

"Credit card companies have a rocky road ahead of them," said Linda Sherry of Consumer Action in San Francisco. "Consumers are getting increasingly worried and angry about how their personal information is being used and protected. I wouldn't be surprised to see the federal government step in soon."

Continued in the article.

The Gartner Report is at http://www3.gartner.com/DisplayDocument?doc_cd=113282 

Event On 18 February 2003, Visa, MasterCard and American Express confirmed that a computer hacker had recently accessed 8 million credit card records, including 2.2 million MasterCard accounts and 3.4 million Visa accounts. The hacker targeted Data Processors International, a merchant processor that mainly processes catalog and other card-not-present transactions. The card associations began to notify their member institutions in early February 2003. The card companies said that none of the information accessed was used fraudulently and that all card issuing banks were alerted. But fraud could potentially occur later on using these compromised records.

First Take Although zero-liability policies protect card holders from paying for unauthorized or fraudulent charges, they do not protect consumers from identity theft and credit report nightmares that can follow. Seven percent of online adult consumers surveyed by Gartner in September 2002 reported being victimized by credit card fraud, and 1 percent reported having their identity stolen. However, since stolen credit card data makes stealing identities easy, Gartner believes identity theft will affect substantially more than 1 percent of this population. The credit card industry has focused too much on reducing its fraud costs and not enough on protecting consumer information. Up to now, no one had much incentive to address the problem. Card issuers seldom notify consumers about hacking incidents they learn about through merchants or processors. The issuers claim they don't really know if a card was compromised, so they wait to see whether a consumer reports fraud against the card. Giving consumers replacement cards costs the issuer about $35 each. When fraud occurs in a physical store, the issuer bears the cost, but the merchant bears the cost of fraud for Internet, telephone and mail orders. If the present case follows typical patterns, the card associations will probably fine the processor whose site was hacked or possibly just issue a stiff warning. However, rising levels of identity theft and consumer anger will lead to onerous legislation unless credit card companies move aggressively. Indeed, a recent California law (SB 1386) will require any company that sells to California citizens (just about every online merchant) to notify consumers. Accordingly, Gartner recommends: Card companies should enforce requirements that all online credit card databases use encryption or other methods to ensure they aren't compromised. Card companies should improve the vulnerability scanning of their online merchants and processors to find weaknesses before attackers do. Card issuers should immediately inform consumers when their card information has been compromised so that they can try to protect themselves against identity theft by notifying credit bureaus and monitoring their own credit reports to catch problems early. Analytical Sources: Avivah Litan and John Pescatore, Gartner Research Recommended Reading and Related Research "Credit Card Companies Provide Little Relief for Online Fraud" — Through 2005, online retailers will have to rely primarily on their own fraud-fighting systems and staff. By Avivah Litan "Holiday Fraud Causes Huge Losses for Online Retailers" — E-tailers must continue working on their back-end fraud prevention programs so that they don't turn away good sales and don't turn off convenience-seeking consumers. By Avivah Litan (You may need to sign in or be a Gartner client to access all of this content.)

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

From The Wall Street Journal Accounting Educators' Review on March 7, 2003

TITLE: 'Goodwill' Is Not an Option 
REPORTER: T.J. Rodgers 
DATE: Mar 04, 2003 PAGE: B2 LINK: http://online.wsj.com/article/0,,SB1046721015191077400,00.html  
TOPICS: Cash Flow, Accounting, Earnings Quality, Financial Accounting, Financial Accounting Standards Board, Financial Analysis, Financial Statement Analysis, Generally accepted accounting principles, Goodwill, Regulation, Stock Options

SUMMARY: The Financial Accounting Standards Board is revisiting accounting for employee stock options. The author of this article argues that the quality of accounting information would be further reduced by expensing stock options. Questions focus on the usefulness of GAAP reported earnings and pro forma earnings.

QUESTIONS: 
1.) What are stock options? Describe the current accounting treatment for stock options granted to employees.

2.) Do you think that stock options granted to employees should be expensed? Support your answer.

3.) What are GAAP reported earnings? What are pro forma earnings? Should GAAP earnings agree with pro forma earnings? Support your answer.

4.) What are the major differences between purchase and pooling accounting? Why does the author argue that eliminating pooling accounting reduced the quality of accounting information.

5.) Compare and contrast earnings with cash flow from earnings. Respond to the statement "the goodwill gaffe also damaged the basic integrity of GAAP accounting by decoupling earnings from cash flow."

SMALL GROUP ASSIGNMENT: Draft a letter to the author of this article. Your letter should either support or renounce the arguments presented in the article. Your letter should include logical arguments to support your position.

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 employee stock option accounting are at http://www.trinity.edu/rjensen/theory/sfas123/jensen01.htm 

Stock Options
If the FASB and the IASB require expensing of stock options when vested rather than exercised, it will have really adverse effects on the bottom lines of some companies who rely heavily upon employee stock options for compensation.  This is why the U.S. House and Senate are already gearing up for a fight with the FASB and possibly SEC due to heavy lobbying pressures.  In the March 31, 2003 issue of Barron's on Page 28, the following sample impacts are provided:

Note that adjustments for many more companies are available in the "Core Earnings" revisions from Standard and Poors at http://www2.standardandpoors.com/NASApp/cs/ContentServer?pagename=sp/Page/PressSpecialCoveragePg&b=5&r=1&s=3&ig=1026841911315 
I also created the shorter URL --- http://snurl.com/CoreEarnings 

In response to growing concern about companies earnings reports, Standard & Poor’s has introduced a new methodology called “Standard & Poor’s Core Earnings.” The ultimate goal is to lead investors and analysts to a consensus on earnings calculations, and bring more transparency and consistency to earnings analysis and forecasts.

Bob Jensen's threads on these this controversy can be found at http://www.trinity.edu/rjensen/theory/sfas123/jensen01.htm 

Artificial stupidity The saga of Hugh Loebner and his search for an intelligent bot has almost everything: Sex, lawsuits and feuding computer scientists. There's only one thing missing: Smart machines --- http://www.salon.com/tech/feature/2003/02/26/loebner_part_one/index.html 

The latest iteration of the Nigerian e-mail swindle/scammers pose as buyers interested in big-ticket items for sale on the Net. Thanks to a little-known U.S. banking loophole, they're bilking Americans out of thousands --- http://www.wired.com/news/culture/0,1284,56829,00.html 

Individuals and companies are victims of newer versions of Nigerian scams. The Sacramento Bee reported the latest variation yesterday. A credit union honored a Nigerian check for $45,000. See the full article at http://www.sacbee.com/content/news/story/6213872p-7168495c.html
(Paul Krause alerted me to the above link.)

The old version of the Nigerian scam consists of e-mails that request help in moving a fortune out of Nigeria. Anyone providing their bank account number to the solicitors is promised a big payoff -- but the victims end up losing money.

The latest offshoot involves the mailing of bogus checks that recipients are urged to cash at their banks. It says they can keep a portion of the money, then wire the rest to Nigeria.

"The bad guys are recruiting people ... who have good credit and good banking relations" to pass rubber checks without knowing it, said Jerry Kinlock, president and CEO of the Sacramento Credit Union.

Five weeks ago, the Credit Union unwittingly honored a $45,000 phony check that one of its members had received from Nigerian con artists, he said.

Lazy guide to net culture: Nigerian Scam Baiting --- http://www.news.scotsman.com/topics.cfm?id=272762003&tid=759 

This week’s online fad: Nigerian Scam Baiting

Does this ring any bells?

GREETINGS MY BLESSED FRIEND,

A MUTUAL FRIEND HAS RECOMMENDED YOU AS A MOST TRUSTY AND SERIOUS PERSON TO DO BUSINESS WITH.

I AM THE WIDOW OF THE LATE SANI ABACHA OR HEAD OF THE PAN-AFRICA BANK IN LAGOS OR EXECUTOR OF THE WILL OF THE LATE SIR WALDO POPPYSOCKS.

I AM IN THE UNFORTUNATE POSITION OF NEEDING TO MOVE $315 MILLION OF SOMEONE ELSE’S MONEY OUT OF MY COUNTRY. AS THIS IS HUGELY ILLEGAL I NEED THE HELP OF AN ACCOMPLICE BASED ABROAD. OBVIOUSLY I HAVE CHOSEN YOU, A COMPLETE STRANGER.

FOR YOUR HELP IN THIS MATTER, YOU WILL RECEIVE 50% OF THE TOTAL SUM.

BUT WE WILL NEED TO PAY EXPENSES OF $5,000 TO MOVE THE MONEY. SADLY, I CANNOT PAY THIS EVEN THOUGH I HAVE JUST TOLD YOU I HAVE MILLIONS IN THE BANK.

WE NEED TO ACT QUICKLY SO COULD YOU SEND ME YOUR NAME, ADDRESS, FAX NUMBER, BANK DETAILS, INSIDE LEG MEASUREMENT AND A NOTE OF WHEN YOUR HOUSE WILL BE UNOCCUPIED.

ALSO I WILL NEED A MONEY TRANSFER OF SEVERAL THOUSAND DOLLARS FOR THE ABOVE CHARGES.

OH AND DON’T TELL ANYONE YOU’RE DOING THIS BECAUSE IT’S ALL ILLEGAL.

FINALLY, COULD YOU FLY OUT TO AFRICA SO THAT SEVERAL LARGE AND VIOLENT ACCOMPLICES OF MINE CAN BEAT SEVEN SHADES OF SHIATSU OUT OF YOU AND HOLD YOU HOSTAGE UNTIL YOUR POOR RELATIVES PAY US A HUGE RANSOM FOR YOUR GULLIBLE CARCASE.

MAY THE LORD BLESS YOU, ETC, ETC, ETC

If you have not received an email similar to this then you either do not have a computer or are a programming genius who has developed some kind of wonder anti-spam software that is worth billions.

The above parody is a distilled version of the classic Nigerian 419 scam. The name reflects such cons’ usual country of origin and the section of its penal code that they violate. The deception is also known as West African advance fee fraud.

The details differ but the offer is always the same: earn millions by helping strangers illegally move money, don’t tell anyone and send sensitive financial information followed by thousands of dollars.

NB: if your IQ is slightly lower than that of the average goldfish it is worth reinforcing such offers are a total con. The only money that will be moving is yours. The endgame can involve a trip to a foreign country where you will be beaten up and held hostage.

The scam has been around for years and has evolved in parallel with communication technology. First the letters came by post, then by fax. Now they have embraced email and flood in-boxes around the world like some kind of e-Biblical plague.

Such letters from Maryam Abacha, corrupt Nigerian government officials and over-charging West African contractors are among the most common forms of spam, rivalling porn, free "Viagra" and "intimate enhancement" products.

419s are easy to spot. Many of them use a lot of religious language to show how sincere they are, their approach to spelling is refreshingly free form and a disproportionate number of them have a penchant for WRITING IN CAPITALS.

The peculiar style of these messages has attracted a cult following. They offer fertile ground for parody. There is even a site that randomly generates personalised 419 spam based on a few key words you have chosen. Have a go here.

Despite all this, people still fall for these ridiculous gambits and greed induces gullibility in the face of reason. In 2002, some 150 Britons were taken in by these fraudsters to the tune of £8.4 million. The US Secret Service estimates that Americans lose $100 million dollars a year to these scams. That’s an awful lot of money and not very much sense.

Unsurprisingly, the police take this issue very seriously. The Metropolitan Police have a comprehensive guide to the fraud here.

Others however, are fighting back outside the law by tying the fraudsters up in pointless correspondence. This is known as Nigerian Scam Baiting.

It has been dubbed the new Internet bloodsport.

One group of scam baiters, the Chaos Project, invites others to join in thus: "Perhaps you too will be inspired to adopt a 'pet Nigerian fraudster'. Remember, as well as amusing yourself and your friends, you are doing the world a service by monopolising the time and frustrating the efforts of these people."

Of course, there are risks associated with this kind of behaviour. The fraudsters are, after all, criminals and don’t take kindly to interference.

Wannabe e-vigilantes set up email accounts under assumed names (it's very important not to use a traceable account) and use these to play the fraudsters along. They answer the invitation enthusiastically, send off false details and see how long they can keep the pretence up. They even forge receipts for money transfers and airline tickets to show the criminals that they are serious.

Some online crime fighters don’t just restrict themselves to wasting the fraudsters’ time. They mock them – and post the results on websites like hunters displaying the heads of prey on walls. You can read some examples on Scamorama, which celebrates scam baiters.

Clueless 419 criminals have carried out extensive correspondence with such individuals as R U Sirrius, Hans Gneesunt-Boompsadazi and Stew de Baker Hawke (the Studebaker Hawk was a 1950s car).

One 419 perpetrator demanded a photograph of the person he was trying to defraud and was rewarded with a picture of the male model Fabio. After some questions, he accepted this as proof of identity and the email relationship continued until the penny finally dropped.

We are not dealing here with a criminal mastermind to rival Professor Moriarty.

These email exchanges are like a game of tennis. The fraudster wants to conclude matters quickly. The art of the baiter is to stretch things out for as long as possible without arousing suspicion. The "victim" may also make bizarre demands of their would-be beneficiary. The fraudster has to keep their correspondent happy and has no choice but to play along, often answering questions of a sexual nature.

However, the Everest of scam baiting is to con the conmen and get the fraudsters to part with cold hard cash. Only a few have managed this. One, writing under the moniker Bart Simpson, managed it by telling his Nigerian criminal target that he was being courted by another offer from West Africa. Bart said that this other correspondent had sent him $5 in a greeting card and he would sever his relationship unless the fraudster did the same thing.

The money duly arrived. While $5 is not much, it's the principle that counts.

Particularly vindictive anti-spammers will also send "supporting documents" to the fraudsters. When downloaded, these are found to contain not helpful bank details but particularly vicious viruses that cripple the criminal’s computers.

One scam baiter managed to get her target to fall for this seven times before he got the message. Read how here. This means he either saw seven expensive PCs reduced to smoking rubble or spent an awful lot of money on repairs. It's hard to feel much sympathy for him.

Of course, this kind of vigilanteism is utterly reprehensible and legally questionable.

It just happens to be very amusing as well.

Bob Jensen's threads on these types of frauds are at http://www.trinity.edu/rjensen/fraud.htm#ThingsToKnow 

Mark Wellesley-Wood, DRD’s chairman, has been dealt a potentially crippling blow following an extraordinary letter of resignation served last night by company secretary Maryna Eloff --- http://www.miningweb.co.za/ 

Barbara Ley Toffler is the former Andersen was the partner-in-charge of 
Andersen's Ethics & Responsible Business Practices Consulting Services.

Title:  Final Accounting: Ambition, Greed and the Fall of Arthur Andersen 
Authors:  Barbara Ley Toffler, Jennifer Reingold
ISBN: 0767913825 
Format: Hardcover, 288pp Pub. 
Date: March 2003 
Publisher: Broadway Books

Book Review from http://www.amazon.com/exec/obidos/tg/stores/detail/-/books/0767913825/reviews/002-8190976-4846465#07679138253200 

Book Description A withering exposé of the unethical practices that triggered the indictment and collapse of the legendary accounting firm.

Arthur Andersen's conviction on obstruction of justice charges related to the Enron debacle spelled the abrupt end of the 88-year-old accounting firm. Until recently, the venerable firm had been regarded as the accounting profession's conscience. In Final Accounting, Barbara Ley Toffler, former Andersen partner-in-charge of Andersen's Ethics & Responsible Business Practices consulting services, reveals that the symptoms of Andersen's fatal disease were evident long before Enron. Drawing on her expertise as a social scientist and her experience as an Andersen insider, Toffler chronicles how a culture of arrogance and greed infected her company and led to enormous lapses in judgment among her peers. Final Accounting exposes the slow deterioration of values that led not only to Enron but also to the earlier financial scandals of other Andersen clients, including Sunbeam and Waste Management, and illustrates the practices that paved the way for the accounting fiascos at WorldCom and other major companies.

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. Toffler was in a position to know when something was wrong. In her earlier role as ethics consultant, she worked with over 60 major companies and was an internationally renowned expert at spotting and correcting ethical lapses. Toffler traces the roots of Andersen's ethical missteps, and shows the gradual decay of a once-proud culture.

Uniquely qualified to discuss the personalities and principles behind one of the greatest shake-ups in United States history, Toffler delivers a chilling report with important ramifications for CEOs and individual investors alike.

From the Back Cover "The sad demise of the once proud and disciplined firm of Arthur Andersen is an object lesson in how 'infectious greed' and conflicts of interest can bring down the best. 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

“This exciting tale chronicles how greed and competitive frenzy destroyed Arthur Andersen--a firm long recognized for independence and integrity. It details a culture that, in the 1990s, led to unethical and anti-social behavior by executives of many of America's most respected companies. The lessons of this book are important for everyone, particularly for a new breed of corporate leaders anxious to restore public confidence.” -Arthur Levitt, Jr., former chairman of the Securities and Exchange Commission

“This may be the most important analysis coming out of the corporate disasters of 2001 and 2002. Barbara Toffler is trained to understand corporate ‘cultures’ and ‘business ethics’ (not an oxymoron). She clearly lays out how a high performance, manically driven and once most respected auditing firm was corrupted by the excesses of consulting and an arrogant culture. One can hope that the leaders of all professional service firms, and indeed all corporate leaders, will read and reflect on the meaning of this book.” -John H. Biggs, Former Chairman and Chief Executive Officer of TIAA CREF

“The book exposes the pervasive hypocrisy that drives many professional service firms to put profits above professionalism. Greed and hubris molded Arthur Andersen into a modern-day corporate junkie ... a monster whose self-destructive behavior resulted in its own demise." -Tom Rodenhauser, founder and president of Consulting Information Services, LLC

"An intriguing tale that adds another important dimension to the now pervasive national corporate governance conversation. -Charles M. Elson, Edgar S. Woolard, Jr., Professor of Corporate Governance, University of Delaware

“You could not ask for a better guide to the fall of Arthur Andersen than an expert on organizational behavior and business ethics who actually worked there. Sympathetic but resolutely objective, Toffler was enough of an insider to see what went on but enough of an outsider to keep her perspective clear. This is a tragic tale of epic proportions that shows that even institutions founded on integrity and transparency will lose everything unless they have internal controls that require everyone in the organization to work together, challenge unethical practices, and commit only to profitability that is sustainable over the long term. One way to begin is by reading this book. –Nell Minow, Editor, The Corporate Library

About the Author Formerly the Partner-in-Charge of Ethics and Responsible Business Practices consulting services for Arthur Andersen, BARBARA LEY TOFFLER was on the faculty of the Harvard Business School and now teaches at Columbia University's Business School. She is considered one of the nation's leading experts on management ethics, and has written extensively on the subject and has consulted to over sixty Fortune 500 companies. She lives in the New York area. Winner of a Deadline Club award for Best Business Reporting, JENNIFER REINGOLD has served as management editor at Business Week and senior writer at Fast Company. She writes for national publications such as The New York Times, Inc and Worth and co-authored the Business Week Guide to the Best Business Schools (McGraw-Hill, 1999).

Also see the review at  http://www.nytimes.com/2003/02/23/business/yourmoney/23VALU.html 

Here is some earlier related material you can find at http://www.trinity.edu/rjensen/fraudVirginia.htm 

From The Wall Street Journal Accounting Educators' Review on March 14, 2003

TITLE: Bristol-Myers Says Accounting Was 'Inappropriate,' Inflated Sales 
REPORTER: Gardiner Harris 
DATE: Mar 11, 2003 
PAGE: A2 
LINK: http://online.wsj.com/article/0,,SB1047061088593427800,00.html  
TOPICS: Accounting, Accounting Changes and Error Corrections, Revenue Recognition

SUMMARY: Bristol-Myers Squibb Co. announced that sales reported between 1999 and 2002 were inflated by between $2.75 billion and $750 million. Questions focus on revenue recognition principles and correction of errors.

QUESTIONS: 
1.) When should revenue be recognized? Did Bristol-Myers violate this basis revenue recognition principle? Support your answer.

2.) Did sales targets contribute to the inappropriate sales reported between 1999 and 2002? Support your answer.

3.) Why is it inappropriate to recognize revenue for sales made to suppliers that are in excess of supplier demands?

4.) How will the adjustments to prior years sales be reflected in the financial statements of Bristol-Myers?

5.) Explain the following comments: "the restatement would involve simple shifting sales from earlier periods to 2002 and 2003...." and, "extra sales had disappeared, "primarily due to changes in accruals from sales returns, rebates" and accounting changes.'

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

Huge Growth in Derivatives Trading

March 21, 2003 message from Risk Waters Group [RiskWaters@lb.bcentral.com] 

The OTC derivatives market continued to grow strongly in the first half of the year, according to the International Swaps and Derivatives Association. The credit derivatives market grew 37%, with total notional outstandings reaching $2.15 trillion during the first half of 2002, the trade body said. Notional outstanding volume in interest rate and currency derivatives increased 20%, to $99.83 trillion, in the first half, while equity derivatives outstanding volumes rose to $2.45 trillion - up 6%. "The continued pace of growth in the over-the-counter derivatives markets during times of economic and political uncertainty demonstrates their importance as a mechanism for mitigation and dispersion of the risks our members encounter in the course of their business," said Bob Pickel, Isda chief executive. "The acceleration in use of credit derivatives in particular is testimony to the effectiveness of this product set in the redistribution of credit exposures to those firms desirous of adopting them."

Meanwhile, confidence built this week that the US could achieve a swift victory in its invasion of Iraq. This sentiment prompted a raft of sellers to enter the credit default swaps market. The cost of protection for France Telecom and Deutsche Telekom debt was 20bp tighter on the week at around 200bp-mid. Other active names, including automaker Ford and engine-maker Rolls Royce, were 15bp to 20bp tighter for the week, trading at 530-mid and 290bp-mid, respectively.

"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!"

He does not elaborate on the topic or cite a source for the $128-trillion figure.

Mr. Watsa's letter, dated March 3, appears in Fairfax's annual report for 2002, which became available on-line last Friday.

Mr. Buffett, the widely respected chairman of Berkshire Hathaway Inc. of Omaha, Neb., called derivatives "time bombs" and potentially lethal "financial weapons of mass destruction" in his annual letter to shareholders.  He said derivatives had been used to facilitate some "huge-scale frauds and near frauds" and warned of the dangers posed by the concentration of much of the business in the hands of "relatively few" derivatives dealers, who also trade widely with one another.  He warned of a possible chain reaction that could lead to a meltdown of the world's financial system.

Mr. Buffett, whose corporate empire is based on insurance, has been dubbed the Oracle of Omaha and, at least until Fairfax's financial and stock market performance ran into problems several years back, observers sometimes compared Mr.Watsa with him.

Derivatives contracts are instruments that call for money to change hands at some future date, with the amount to be determined by one or more reference items, such as interest rates, stock prices or currency values.  Financial institutions and other companies typically use swaps and other derivatives to hedge various types of risk they face from, for instance, fluctuations in currency exchange rates and interest rates.

Continued in the article.

Note from Bob Jensen:  The above quotations seem to be Year 2002 and 2003  Déjà Vu  in terms of all the bad ways investment bankers cheated investors in the 1980s and 1990s.  Read passage from Partnoy's book quoted below.

When I first began reading a novel about derivatives, two paragraphs in the Preface really caught my attention.  They seem to apply more so today in the aftermath of Enron's trading disasters. Those  paragraphs written in 1997 read as follows:

Derivatives have become the largest market in the world.  The size of the derivatives market, estimated at $55 trillion in 1996, is double the value of all U.S. stocks and more than ten times the entire U.S. national debt.  Meanwhile, derivative losses continue to multiply.  

Of course, plenty of firms made money on derivatives, including Morgan Stanley, and the firm's derivatives group is thriving, even as derivatives purchases lick their wounds.  Some clients tired of having their faces ripped off or being blown up, and business declined briefly in 1995 and 1996.  Many of us quit during this period, some leaving for less brutish firms.  
(Continued on Page 15)
Frank Partnoy in FIASCO:  The Inside Story of a Wall Street Trader (New York:  Penguin Putnam, 1997, ISBN 0 14 02 7879 6)

We have been following the transition of public accountants from the most trusted profession in the United States to one of the least trusted.  It is interesting how this transition is taking place amidst a somewhat similar transition in investment banking and securities trading in general.  The following quotation from the above Preface may really open your eyes:

From 1993 to 1995, I (Frank Parnoy) sold derivatives on Wall Street.  During that time, the seventy or so people I worked with in the derivatives group at Morgan Stanley in New York, London, and Tokyo generated total fees of about $1 billion --- an average of almost $15 million a person.  We were arguably the most profitable group of people in the world.

My group was the biggest moneymaker at the firm by far.  Morgan Stanley is the oldest and most prestigious of the top investment banks, and the derivatives group was the engine that drove Morgan Stanley.  The $1 billion we made was enough to pay the salaries of most of the firm's ten thousand worldwide employees, with plenty left for us.  The managers in my group received millions and millions in bonuses;  even our lowest level employees had six-figure incomes.  An many of us, including me, were still in our twenties.

How did we make so much money?  In part, it was because we were smart.  I worked with the greatest minds in the derivatives business.  We mastered the complexities of modern finance, and it is no coincidence that we were called "rocket scientists."  (Page 15)

This is the part that indirectly relates to the changing business model of public accountants.

This was not the Morgan Stanley of yore.  In the 1920s, the white-shoe (in auditing that would be black-shoe) investment bank developed a reputation for gentility and was renowned for fresh flowers and fine furniture (recall that Arthur Andersen offices featured those magnificent wooden doors), an elegant partners' dining room, and conservative business practices.  The firm's credo was "First class business in a first class way."

However, during the banking heyday of the 1980s, the firm faced intense competition from other banks and slipped from its number one spot.  In response, Morgan Stanley's partners shifted their focus from prestige to profits --- and thereby transformed the firm.  (Emphasis added)  Morgan Stanley had swapped its fine heritage for slick sales-and-trading operation --- and made a lot more money.

Other banks --- including First Boston, where I worked before I joined Morgan Stanley --- could not match Morgan Stanley's aggressive sales tactics.  By every measure, the firm had been recast.  The flowers were gone.  The furniture was Formica.  Busy managers ingested lunch, if at all, at a crowded donut stand jammed between two hallways along the trading floor.  Aggressive business practices inspired a new credo:  "First class business in a second class way."  After decades of politesse, there were savages at Morgan Stanley."  
(Continued on Page 14 of the book cited above).

Added notes from Bob Jensen

CEO Robert Gannon allowed himself to be seduced by investment bankers from Goldman Sachs to sell off all the solid assets (e.g., a hydro power dam) for pie in the sky so Goldman Sachs could earn $20 million in sales commissions and Gannon could become a multi zillionaire.  The February 9, 2003 airing of Sixty Minutes of this scandal is one of the most sickening things I've learned about in this saga of recent corporate scandals.  http://www.cbsnews.com/stories/2003/02/06/60minutes/main539719.shtml
This should be another chapter in Partnoy's book.

I was sitting in Times Square (where I was Program Director for the 1994 American Accounting Association Annual Meetings in the Marriott Marquis Hotel) and captured an address by the Chairman of the Financial Accounting Standards Board (Denny Beresford) quoting that until 1993 he thought derivatives were "something a person his age took when prunes did not quite do the job."  You can hear my MP3 recording of Denny's remarks (along with related and free audio and video clips) at http://www.cs.trinity.edu/~rjensen/000overview/mp3/133summ.htm#Introduction 

"Gold hedging foe not friend, says Goldcorp," Mineweb, March 12, 2003 --- http://www.mips1.net/mgp03.nsf/Current/80256CE100291EEB42256CE7002A8288?OpenDocument 

TORONTO – In one of the more controversial presentations at this year’s PDAC conference, mid-tier Canadian gold producer, Goldcorp, came out blazing against the practice of gold hedging. North America’s biggest non-hedger seized the opportunity presented by the annual Toronto mining talkshop to beat its well-worn anti-hedging drum, backing up its arguments with quotes from Warren Buffett -- a lately vociferous anti-hedger who has called derivative instruments “financial weapons of mass destruction”.

March 10 message from Dennis Beresford [dberesfo@terry.uga.edu] 

Bob,

You might be interested in the attached item that was published on Mineweb last Friday.

Denny

"The Idiot's Guide to Hedging and Derivatives," Mineweb March 7, 2003 --- http://www.mips1.net/MGCurve.nsf/Current/8525686A00324CF585256CE2006203E9?OpenDocument 

Ismail is a successful mule trader in Peshawar. Every year Ismail delivers 30 mules to the Kabul Mule Market and gets $40 per mule. This year however, the Khyber Pass is full of warlord militias, so Ismail is not sure he can drive his mules to market without losing a mule here and there. Also, the demand for mules in Kabul seems to be dropping. Maybe he'll only be able to sell 20 mules, or, God forbid, 15, and then be forced to feed and water the rest of them on a money-losing trek back home. In other words, it's a scary market and Ismail is worried about feeding his family. What Ismail needs is to limit his risk with an Enron derivatives package.

First he pays $2 per mule for a Khyber Pass Derivative, so that any mule killed or stolen by warlords will be reimbursed at the rate of $20 per mule -- half the going market rate, but still better than taking a total loss. Next he sells Enron Mule Futures. For $28 per contract, he guarantees delivery of a mule in three months time. He sells 15 of these, figuring that a guaranteed $28 mule sale is better than showing up in Kabul and discovering that the mule buyers have been killed by stray bombs.

Meanwhile, at the Enron Mule Trading Desk in Houston, eagle-eyed yuppie are studying the worldwide mule markets and starting to have their doubts about those $28 delivery contracts. Mule use is dropping all over Afghanistan, even as the mule count is dwindling. Better resell eight of those15 contracts to a European commodities broker for $24 each, then make up that $32 loss somewhere else while cutting the company's exposure in half. But how to hedge the risk on the other seven?

Aha! A blip on the computer screen. A temporary mule shortage in southern Iran! With a current mule price of $42 in Tehran, Enron could offer a Linked Mule Swap Double Derivative tied to the gap between the price of mules delivered in Kabul on a given date and the price in Tehran on the same date. Sure, you would rather have the quick-and-clean Iran sale, instead of the sale in Kabul that requires trucking the mules to a foreign market. But even if you add in $4 per mule for transport through militia-held territory and averaged the markets together, you can still clear eight bucks just on the gap alone.

Enron's average price-per-future-mule is now $32.57 when you include the $4-per-mule loss on the mule futures dumped in Europe. But based on the amazing $12 Kabul/Tehran trading gap, they can easily put together a "delivery in either market" contract that will allow them to ask $36 per mule on their Mule Online Internet trading system.

The first mule future sells instantly for $36, and the price bobs up to $36.50. Two mules go for $36.75, and then there's a big jump for the last three mules to $37.90. Enron has now off-loaded all its price-based mule futures liability for a profit of $31.70. But this doesn't mean they're out of the mule market in Central Asia. It's still two months until Ismail delivers his 30 mules, and Enron is on the hook for his Khyber Pass derivative insurance policy. Things are not looking good in that part of the world, either. The chances of a mule being picked off as a road-passage tax are pretty high, and the loss of the whole herd would be a $600 liability.

Quickly, the financial boys go to work, and part of that liability is resold to a consortium of Singapore banks, Australian mutual funds, and Saudi Arabian arms merchant Adnan Kashoggi, thereby reducing Enron's percentage to 25%, or $150 in potential liability against a $15 premium (remember the $2 per mule paid by Ismail), and Enron also takes a brokerage fee of $20 from the three other partners, thereby reducing its real liability to just $120.

But that's still too much of a spread, so Enron continues to hedge. Fortunately, the company has such a diversified trading floor that Enron mule-market experts can walk over to the traders in the warlord-militia derivatives department. Sure enough, at least four tribes near the Khyber Pass are increasingly concerned about profit margins. There simply aren't enough people to rob. Things have gotten so bad, in fact, that the warlords are hedging against the oncoming winter by taking futures positions in stolen chickens, stolen humanitarian aid trucks, and Western hostages.

There's not a mule market yet, because the warlords have successfully converted many of the recalcitrant villagers into pack animals. But Enron knows how to MAKE markets. Quickly the numbers-crunchers go to work, and they soon determine that the average number of stolen mules per100-man militia is 1.4 per year. That represents anywhere from $28 to $56 in lost mule-thievery income if the Khyber Pass is closed or inhospitable to traders from Pakistan. Amortizing that amount over 12 months, the warlords have an exposure of anywhere from $2.33 to $4.67 per month in lost pillage. Hence Enron announces the new Highway Robbery Derivative, in which each tribe is guaranteed the value of two stolen mules in each 12-month period in return for paying a premium of $4 per month.

Enron's hedge is now complete, and it is a beautiful thing to behold. The chances of Ismail losing a mule to a raiding party are approximately one in 30, or 3.33 percent. Since he's paying $60 for his derivative contract, the expected loss of 3.33 percent of his herd would result in a payment of only $20 -- a more than comfortable spread. Meanwhile, if the mule is stolen by a warlord holding a Highway Robbery Derivative, then the payment to the other side would only be $28 against premiums of $48. If Ismail simply passes through the Khyber Pass without incident and sells all his mules at the standard price, Enron pockets $60 from Ismail and $48 each from four warlords, in addition to the previous profit of $31.70 from that heady Internet mule-futures trading day and the $20 in packaging commissions.

If each warlord steals his standard 1.4 mules per year, then Enron still owes six-tenths of one mule to the warlord, or about $22.20 based on a $37 sales price. Total expected profit, based on 5.6 stolen mules, one of which is stolen from Ismail: $143.20. Total profit from all Ismail-related mule transactions: $194.90.

See, it's simple when you know how it works. Ask Arthur Andersen.