Accounting Scandal Updates and Other Fraud on March 31, 2005
Bob Jensen at Trinity University

 

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

Other Documents

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

Resources to prevent and discover fraud from the Association of Fraud Examiners --- http://www.cfenet.com/resources/resources.asp 

Self-study training for a career in fraud examination --- http://marketplace.cfenet.com/products/products.asp 

Source for United Kingdom reporting on financial scandals and other news --- http://www.financialdirector.co.uk 

Updates on the leading books on the business and accounting scandals --- http://www.trinity.edu/rjensen/Fraud.htm#Quotations 

I love Infectious Greed by Frank Partnoy ---  http://www.trinity.edu/rjensen/Fraud.htm#Quotations 

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

Future of Auditing --- http://www.trinity.edu/rjensen/FraudConclusion.htm#FutureOfAuditing 


If the Big Four shrinks to the Big Three, some clients will continuously employ all three firms.  Accounting Firm 1 hired for audits is not allowed to perform tax services or information system consulting.  Accounting Firm 2 hired for tax services runs a liability risk if it also designs the information system feeding the tax information.  Accounting Firm 3 hired for information systems consulting is not allowed to perform audits and probably should not perform tax services. 

It will be very confusing unless something is done to distinguish the external accountants in the client's offices. I suggest color codes.

What will the colors be,
after there are but three?

I wonder if the Big Three will adopt distinct colors.  As I recall Andersen employees preferred orange shirts when demonstrating outside the Justice Department (in a pouring rain) around the time Andersen was being tried for obstruction of justice in the destruction of Enron’s audit files.  White has been pretty well taken up by medical services.  Black has always been the most popular auditor color --- when I worked for Ernst, I was required to have a black fedora to match my black suits.  But undertakers also prefer black.  Traders in the commodity pits wear bright colors.  Why can’t accountants do the same?

Seriously, I always thought Andersen's choice of orange was rather ironic. This is too close to prison-orange for a firm that is trying to fend off a criminal conviction.

Quotations

FTC Annual Fraud Report
The FTC of the US has released its Annual Fraud Report, in which, among other things, it reports an increase in identity theft, amounting to losses of as much as $548 million in the US alone.
FTC: Identity theft, online scams rose in '04 - Computerworld
Gerald Trite's Business Blog, February 17, 2005 --- http://www.zorba.ca/blog.html 

United Nations (read that United Nepotism)
The Biggest Scam in History

The U.N. Oil-for-Food scandal is the biggest scam in the history of humanitarian aid. And it's Kofi Annan's fault. 
Claudia Rosett, "Blame Game, The New Republic, February 16, 2005 --- https://ssl.tnr.com/p/docsub.mhtml?i=20050221&s=rosett022105 

What a complicated web we weave:  Proud Canada Company Linked to U.N. Oil for Food Scandal
But the Fox News story wasn’t prompted by an announcement from Power of some billion-dollar takeover or the appointment of a new senior executive. It was something altogether different: the revelation that the man handpicked by the UN secretary general last April to probe the UN’s scandalized Oil-for-Food program, Paul Volcker, had not disclosed to the UN that he was a paid adviser to Power Corp., a story which had originally been broken by a small, independent Toronto newspaper, the Canada Free Press. Why did the highest-rated cable channel in the U.S. care? Because the more that Americans came to know about Oil-for-Food, which has been called the largest corruption scandal in history, the more the name of this little-known Montreal firm kept popping up. And the more links that seemed to emerge between Power Corp. and individuals or organizations involved in the Oil-for-Food scandal, the more Fox News and other news outlets sniffing around this story began to ask questions about who, exactly, this Power Corp. is. And, they wanted to know, what, if anything, did Power have to do with a scandal in which companies around the world took bribes to help a murderous dictator scam billions of dollars in humanitarian aid out of the UN while his people suffered and starved?
Kevin Steel, "How Montreal's Power Corp. found itself caught up in the biggest fiasco in UN history," Canada Free Press, March 5, 2005 --- http://www.canadafreepress.com/2005/cover030505.htm 


Fraudulent Health Clinics and Doctors:  What happened to ethics?
A group of health clinics and doctors paid thousands of people across the U.S. to undergo unnecessary surgery so they could defraud insurers out of tens of millions of dollars, a lawsuit alleges.  Twelve Blue Cross and Blue Shield health-insurance plans sued a group of Southern California health-care clinics, physicians and others they say are involved in the elaborate scheme.  The scope of the alleged fraud is vast. The insurers claim the clinics paid recruiters to enlist patients in 47 states, then transported the people to California where they underwent unnecessary and sometimes dangerous outpatient procedures.
"Blue Cross Groups Sue Clinics, Doctors, Claiming Insurance Fraud," The Wall Street Journal, March 14, 2005; Page B4 --- http://online.wsj.com/article/0,,SB111076460482378314,00.html?mod=todays_us_marketplace 
Bob Jensen's threads on medical and drug company frauds are at http://www.trinity.edu/rjensen/FraudReporting.htm#PhysiciansAndDrugCompanies 


Amazon Pays $27.5 Million To Settle Securities Suit
Amazon.com Inc. disclosed Friday it has agreed to pay $27.5 million to settle an investor lawsuit alleging securities violations by its officers and directors.  According to its annual report filed with the Securities and Exchange Commission, the Seattle-based Internet retailer said it reached a settlement with plaintiffs lawyers in March. The company expects most, if not all, of the settlement will funded by its insurers.  The complaint was filed by stock and bond holders in August 2003. It alleges that Amazon officers and directors made false or misleading statements from Oct. 29, 1998, through Oct. 23, 2001, about the company's business, financial condition and future prospects, among other things.
"Amazon Pays $27.5 Million To Settle Securities Suit," The Wall Street Journal, March 14, 2005, Page B9 --- http://online.wsj.com/article/0,,SB111054778856777083,00.html?mod=todays_us_marketplace 


Profiteers Heading Legitimate Charities
Charity executives haul home the lion's share striking disparity between what nonprofit fat cats make and industry norms — hundreds of thousands of dollars in many cases — illustrates a troubling lack of city oversight, officials say.  A whopping 200 executives at organizations that provide services for the city's have-nots take home in excess of $150,000 a year. That's more than the salaries of City Council members, the public advocate and all the city's district attorneys.  Another 12 nonprofiteers make more than the top nonprofit earners in the entire state based on the budget size of their groups, according to a survey of 2002 salaries by the nonprofit watchdog Guidestar.org.
"$WEET CHARITY FOR EXECS AT NONPROFITS," New York Post, March 13, 2005 --- http://www.nypost.com/news/regionalnews/42413.htm 
Bob Jensen's threads on charity frauds are at http://www.trinity.edu/rjensen/FraudReporting.htm#CharityFrauds 


It must be nice to get paid nearly $20 million for cheating
Bank of America Corp., which has paid more than $1 billion during the past year in scandal-related settlements and penalties while absorbing a huge acquisition, paid its chairman and chief executive, Kenneth Lewis, a total of $19.3 million in compensation, according to a proxy filing with the Securities and Exchange Commission. The 57-year-old Mr. Lewis, in his fourth year of running the Charlotte, N.C., company, which ranks third in assets among U.S. banks, received a salary of $1.5 million, unchanged from 2003. His bonus rose 6% to $5.7 million from $5.4 million a year earlier.
Betsy McKay, "Bank of America Pays Its CEO $19.3 Million Amid Penalties:  Total for Lewis Followed $1 Billion in Settlements, Absorption of Acquisition," The Wall Street Journal, March 29, 2005; Page A6 --- http://online.wsj.com/article/0,,SB111205640746091429,00.html?mod=todays_us_page_one
Bob Jensen's "Rotten to the Core" threads on banking are at http://www.trinity.edu/rjensen/FraudRotten.htm#InvestmentBanking


It pays to be an accounting cheat because you don't have to return your bonus that you got by cheating
Hundreds of companies have restated earnings in recent years - 414 in 2004 alone, according to a recent study by the Huron Consulting Group. And in many cases, the revisions came in the wake of discoveries of questionable accounting or other possible wrongdoing that meant the numbers leading to bonuses were inaccurate. But a review of restatements by large corporations shows that companies very, very rarely - as in almost never - get that money back. The list of restatements was compiled for Sunday Business by Glass Lewis & Company, a research firm based in San Francisco.
Jonathan D. Glater, "Sorry, I'm Keeping the Bonus Anyway," The New York Times, March 13, 2005 --- http://www.nytimes.com/2005/03/13/business/yourmoney/13restate.html
Bob Jensen's threads on white collar crime are at http://www.trinity.edu/rjensen/FraudConclusion.htm#CrimePays 

CEOs gain from poor performance of share prices
Limiting severance pay for chief executives has been an increasingly popular idea among investors. Shareholder proposals like Mr. Chevedden's went to a vote at 21 companies last year and received an average of 51 percent of the votes.  But AMR was not going to let its shareholders vote on the matter just because it may have seemed to be what investors wanted. No, AMR officials first wanted to make sure that Mr. Chevedden was still eligible to put something on the ballot. So it checked to see how much his shares were worth.  As it turned out, AMR has performed so poorly in the last few years - the price of its stock has fallen about 70 percent since mid-2001 - that Mr. Chevedden's 100 shares are now worth just $900. And that is well below the $2,000 minimum stake the S.E.C. says a shareholder must have if he or she wants to make a proxy proposal.  AMR asked the regulators for permission to exclude Mr. Chevedden's suggestion for that reason. The company even provided evidence of how weak its stock has been lately.  Last month, Mr. Chevedden complained to regulators that AMR was "implicitly bragging about the declining price" of its stock, and he appealed to their sense of fairness. He asked them not to use the ownership requirements to "disenfranchise long-term continuous shareholders" simply because "the company stock price has sunk."  But rules are rules, so the commission sided with AMR. An AMR spokesman said that the company had no choice but to disqualify Mr. Chevedden.
Patrick McGeehan, "The Fine Print Keeps Small Investors Silent," The New York Times, March 13, 2005 --- http://www.nytimes.com/2005/03/13/business/yourmoney/13agenda.html 
Bob Jensen's threads on white collar crime are at http://www.trinity.edu/rjensen/FraudConclusion.htm#CrimePays 

They weren't working solely in their clients' best interest.
The study was instigated by Steven D. Levitt, a self-described "rogue economist" who has applied the analytical tools of his trade to everything from sumo wrestlers to drug-dealing gangs; his work is cataloged in the forthcoming book "Freakonomics," written with Stephen J. Dubner.  Professor Levitt had fixed up and sold several houses in Oak Park, Ill., a suburb of Chicago. When working with real estate agents, he said, "I got the impression they weren't working solely in their clients' best interest."
Daniel Gross, "Why a Real Estate Agent May Skip the Extra Mile," The New York Times, February 20, 2005 --- http://www.nytimes.com/2005/02/20/business/yourmoney/20view.html 
Jensen Comment:  Steven Levitt is a terrific economics professor at the University of Chicago.  You can get a list of his publications at http://www.src.uchicago.edu/users/levit/ 
Over the course of the history of America, real estate fraud has been the most prevalent kind of fraud.  See Bob Jensen's history of fraud in America at http://www.trinity.edu/rjensen/415wp/AmericanHistoryOfFraud.htm 

The question is why?  The answer was not caught on film!
Eastman Kodak Co. said it will restate its previously reported results for 2004 and 2003, lowering earnings, because of accounting errors in pensions, income taxes and other areas.  Kodak said it expects to report results by March 31 and has applied for an automatic extension of time to file the results, which were due yesterday. Kodak said its auditor, PricewaterhouseCoopers, will, as expected, give an adverse opinion on its internal financial-reporting controls. Kodak said it has concluded it has a "material weakness" involving its accounting for retirement benefits as well as for income taxes.
William M. Bulkeley, "Kodak to Restate Results for '03, '04," The Wall Street Journal, March 17, 2005; Page A6 --- http://online.wsj.com/article/0,,SB111101010575381521,00.html?mod=todays_us_page_one 
Jensen Comment:  The external independent auditor for Kodak is PricewaterhouseCoopers (PwC)

Eastman Kodak Co. released preliminary fourth-quarter results in line with expectations, but said its auditors are expected to issue an "adverse opinion" citing "material weaknesses" in its internal financial controls for 2004.Kodak joins a growing list of corporations reporting such problems under new Sarbanes-Oxley rules that went into effect in November. Earlier this month, SunTrust Banks Inc., Atlanta, said it will disclose a material weakness in its annual report. Last month Toys "R" Us Inc. disclosed that it was working to resolve unspecified internal-control issues.
"Kodak to Get Auditors' Adverse View," by William M. Bulkeley and Robert Tomsho, The Wall Street Journal, January 27, 2005, Page A# --- http://online.wsj.com/article/0,,SB110674149783836535,00.html  

Judge tells the jury that Morgan Stanley did it
The judge in a high-profile lawsuit brought by financier Ron Perelman said she regarded Morgan Stanley's failure to produce documents as "offensive" and would instruct the jury that the Wall Street firm helped to defraud Mr. Perelman.  In what legal experts called a highly unusual ruling, Florida Judge Elizabeth Maass wrote that she will tell the jury that Morgan Stanley had a role in helping appliance maker Sunbeam Corp. conceal accounting woes that reduced the value of Mr. Perelman's investment in Sunbeam. The ruling increases the possibility that a jury will find against Morgan Stanley and force the firm to pay Mr. Perelman some or all of the $680 million he says he lost on the investment. In addition he is seeking $2 billion in punitive damages
Suzanne Craig and Kara Scannell, "Judge's Fraud Ruling Puts Heat On Morgan Stanley, Law Firm," The Wall Street Journal, L March 24, 2005; Page A1 ---
http://online.wsj.com/article/0,,SB111162256208888176,00.html?mod=home_whats_news_us
Bob Jensen's "Rotten to the Core" threads are at http://www.trinity.edu/rjensen/FraudRotten.htm

Between a Rock and a Hard Place
Should a CEO whose company is rumored to be in trouble admit publicly that things haven't gone as expected and own up to mistakes? Carol Hymowitz explores a dilemma many executives face.
Carol Hymowitz, "Should CEOs Tell Truth About Being in Trouble, Or Is That Foolhardy?" The Wall Street Journal, February 15, 2005; Page B1--- http://online.wsj.com/article/0,,SB110841983585154468,00.html?mod=todays_us_marketplace 


Bye bye Hank!
At the helm of American International Group Inc., Maurice Greenberg was under mounting pressure. Regulators were applying increasing heat over a transaction AIG did with a unit of Warren Buffett's Berkshire Hathaway Inc., a deal they considered possibly misleading to AIG investors.  Mr. Greenberg, known as Hank, resisted the pressure with the same tenacity he displayed in nearly four decades running what has become the world's largest insurer. But then, in the past week, came the tipping point. The regulators -- relying on nearly 1,000 pages of e-mails and phone-call records -- gave AIG's independent directors an analysis providing new details of the deal and Mr. Greenberg's role in it. And some of that was in conflict with or missing from his statements on the matter.
Monica Langley and Theo Francis, "How Investigations of AIG Led To Retirement of Longtime CEO:  Spitzer's and SEC's Close Look At Big Trove of Documents Put Pressure on the Chief Greenberg: 'I'll Get Going Now'," The Wall Street Journal,  March 15, 2005; Page A1 --- http://online.wsj.com/article/0,,SB111084108330679173,00.html?mod=todays_us_page_one

Bye bye again Hank!
Maurice R. "Hank" Greenberg, the insurance industry's most powerful figure for decades, decided to retire as nonexecutive chairman of American International Group Inc., succumbing to mounting law-enforcement scrutiny of the company he built.
Deborah Solomon and Ian McDonald, "Finally, an AIG Without Hank:  Retirement Ends Last Top Role At the Company Greenberg Built And Comes Amid Investigations, The Wall Street Journal, March 29, 2005; Page C1 --- http://online.wsj.com/article/0,,SB111206560939091696,00.html?mod=home_whats_news_us
Bob Jensen's threads on "rotten to the core" insurance rackets can be found at http://www.trinity.edu/rjensen/fraudrotten.htm#MutualFunds 

Income smoothing makes it not so smooth for A.I.G.'s former CEO
Mr. Greenberg's fall from grace may seem to have been dizzyingly swift, but according to people who have worked for him, analyzed his business and dealt with him as either customer or competitor, the seeds of his ouster were probably sown earlier in his long tenure. Paradoxically, these people say, Mr. Greenberg's ability to produce smooth and steady results in a hugely volatile and complex business was also responsible for his downfall.  Dozens of other A.I.G. transactions are now under scrutiny by investigators, though little is known about them. In a board meeting last Thursday, A.I.G. directors were advised that reversing questionable deals uncovered by the company could force it to restate results by approximately $1 billion, according to a person briefed on the meeting, though the figure could change as the internal review continues.
Gretchen Morgenson, "The Deal That Toppled A.I.G.'s Boss," The New York Times, March 27, 2005 --- 

How did AIG use insurance contracts to sell accounting fraud?
Steven Gluckstern and Michael Palm figured out how to minimize insurers' risk and give customers an accounting edge and a tax break: Multiyear contracts in which the premiums covered most if not all of the potential losses -- but refunded much of the unclaimed money at the end of the contract.  Buyers loved the policies because they could offset losses with loan-like proceeds without disclosing liabilities that would muddy their bottom lines. And the premiums were tax deductible.  Such policies became among the industry's hottest products. Now, two decades later, they are the focus of multiple state and federal investigations into companies suspected of using them to manipulate earnings. And this week, those probes helped topple Mr. Greenberg as chief executive, although he will remain chairman. His company sold one policy later declared a sham by federal authorities and itself bought another -- now the focus of intense scrutiny -- from Berkshire Hathaway Inc., where Messrs. Gluckstern and Palm got their start.  "If used improperly, these contracts can enable a company to conceal the bottom-line impact of a loss and thus misrepresent its financial results," says the Securities and Exchange Commission's Mark Schonfeld, who is overseeing the agency's probe of such policies as the head of its Northeast office.
Ianthe Jeanne Dugan and Theo Francis, "How a Hot Insurance Product Burned AIG:  An Unlikely Duo's New Approach Called 'Finite Risk Insurance' Was a Hit -- Until Inquiries Began," The Wall Street Journal,  March 15, 2005; Page C1 --- http://online.wsj.com/article/0,,SB111084339061279243,00.html?mod=todays_us_money_and_investing 
Bob Jensen's threads on "rotten to the core" insurance rackets can be found at http://www.trinity.edu/rjensen/fraudrotten.htm#MutualFunds 

Regulators are examining whether the American International Group has in recent years burnished its results by striking deals with offshore insurers that appear to be independent companies but that may in fact be affiliates of A.I.G. If these companies are indeed A.I.G.'s affiliates, the transactions between them may not involve a true transfer of risk and may run afoul of insurance accounting rules.
Lynnley Browning, "Investigation of A.I.G.'s Deals Moves Offshore," The Wall Street Journal,  March 23, 2005 --- http://www.nytimes.com/2005/03/23/business/23insure.html?

Earnings Management Deception
The 1999 bulletin also said that if accounting practices were intentionally misleading "to impart a sense of increased earnings power, a form of earnings management, then by definition amounts involved would be considered material." AIG hinted some errors may have been intentional, saying that certain transactions "appear to have been structured for the sole or primary purpose of accomplishing a desired accounting result."
Jonathan Weil, "AIG's Admission Puts the Spotlight On Auditor PWC," The Wall Street Journal, April 1, 2005 --- http://online.wsj.com/article/0,,SB111231915138095083,00.html?mod=home_whats_news_us
Bob Jensen's threads on earnings management are at http://www.trinity.edu/rjensen//theory/00overview/theory01.htm#Manipulation
Bob Jensen's threads on the AIG mess are at http://www.trinity.edu/rjensen/fraudRotten.htm#MutualFunds

A billion here and a billion there, pretty soon it begins to look like real money
Insurance giant American International Group Inc., under regulatory scrutiny, is considering a move to clean up suspected accounting mistakes that may total as much as $3 billion from as many as 30 insurance transactions, according to people familiar with the matter.  The potentially problematic accounting now being examined is far broader than was believed just a week ago, said people familiar with the situation.
Monica Langley and Ian McDonald, "AIG's Concerns Over Accounting Grow Broader:  Insurer Reviews Transactions That Could Total $3 Billion; A Change in Compensation?" The Wall Street Journal,  March 25, 2005; Page A1 --- http://online.wsj.com/article/0,,SB111170837700789265,00.html?mod=home_whats_news_us 
Bob Jensen's threads on AIG's woes are at http://online.wsj.com/article/0,,SB111170837700789265,00.html?mod=home_whats_news_us 

The latest huge Enron-type scandal:  Where was the external auditor, PwC, when all this was going on?
Among AIG's admissions: It used insurers in Bermuda and Barbados that were secretly under its control to bolster its financial results, including shifting some liabilities off its books. Amid the wave of financial scandals that have toppled corporate executives in recent years, AIG's woes stand out. Unlike Enron, WorldCom and HealthSouth -- all highfliers that rose to prominence in the 1990s -- AIG has been a solid blue-chip for decades. Its stock is in the Dow Jones Industrial Average, and its longtime chief, Maurice R. "Hank" Greenberg, was a globe-trotting icon of American business. Civil and criminal probes already have forced the departure of the 79-year-old Mr. Greenberg after nearly four decades at AIG's helm. Investigators are closely examining the actions of Mr. Greenberg and several other top AIG officials who have quit or been ousted in recent days, including its former chief financial officer; the architect of its offshore operations in Bermuda; and its reinsurance operations chief. In addition, the Securities and Exchange Commission could eventually bring civil-fraud charges against the company or executives.
Ian McDonald, Theo Francis, and Deborah Solomon, "AIG Admits 'Improper' Accounting :  Broad Range of Problems Could Cut $1.77 Billion Of Insurer's Net Worth A Widening Criminal Probe," The Wall Street Journal, March 31, 2005; Page A1--- http://online.wsj.com/article/0,,SB111218569681893050,00.html?mod=todays_us_page_one

Underwriting losses: AIG said it improperly characterized losses on insurance policies -- known as underwriting losses -- as another type of loss, through a series of transactions with Capco Reinsurance Co. of Barbados. It said Capco should have been treated as a subsidiary of AIG, a change that will force AIG to restate $200 million of the other losses as underwriting losses from its auto-warranty business. AIG long has prided itself on having among the lowest underwriting losses in the industry -- a closely watched figure.

• Investment income: Through a string of transactions with unnamed outside companies, AIG said it booked a total of $300 million in gains on its bond portfolio from 2001 through 2003 without actually selling the bonds. If it had waited to book the income until it sold the bonds, the income would have come later and been counted as "realized capital gains." That category of income is sometimes treated suspiciously by investors because insurance companies have considerable discretion over when they sell securities in their portfolio.

• Bad debts: The company suggested that money owed to AIG by other companies for property-casualty insurance policies might not be collectible. The company said that could result in an after-tax charge of $300 million.

• Commission costs: Potential problems with AIG's accounting for the up-front commissions it pays to insurance agents and similar items might force it to take an after-tax charge of up to $370 million, the company said.

• Compensation costs: AIG also will begin recording an expense on its books for compensation paid to its employees by Starr International, the private company run by current and former executives. Starr has spent tens of millions of dollars on a deferred-compensation program for a hand-picked group of AIG employees in recent years.

The probe that spurred the AIG admissions stemmed from a broader investigation of "nontraditional insurance," an industry niche that had grown rapidly in the 1990s. In particular, regulators have been concerned about a product called "finite-risk reinsurance."

Reinsurance is a decades-old business that sells insurance to insurance companies to cover bigger-than-expected claims, thereby spreading the losses for policies they sell to individuals and companies. Finite-risk reinsurance blends elements of insurance and loans.

Regulators had become concerned that some insurers were using the policies to improperly bolster their financial results. Their concern: For a contract to count as insurance, it has to transfer risk to the insurer selling the policy. Some finite-risk policies appeared to be more akin to loans than insurance policies -- yet the buyers used favorable insurance accounting.

In December, the SEC opened a broad probe into at least 12 insurance and reinsurance companies, including General Re, ACE Ltd., Chubb Corp. and Swiss Reinsurance Co. All four companies have said they are cooperating with the inquiry.

Key to the inquiry is how the finite-risk transactions were structured and treated on the financial statements of the companies or their clients, these people said. Following the SEC request for information, General Re lawyers combed through their finite-risk insurance deals and turned up roughly a dozen transactions where it wasn't clear that enough risk had been transferred to treat them as insurance. Among those deals was the AIG deal. General Re lawyers quickly alerted the SEC and the New York attorney general's office, which resulted in the current probe.

The catalogue of problems AIG unveiled yesterday was detailed to law-enforcement and regulatory authorities in meetings with the company's outside lawyers in recent days. The company also has fired three senior executives for refusing to cooperate with investigators, including former chief financial officer Howard I. Smith and Michael Murphy, a Bermuda-based AIG executive.

Given its level of cooperation so far, the company almost certainly will be able to reach a civil settlement with authorities, people familiar with the probes said. One of these people compared AIG's cooperation to the approach taken by Michael Cherkasky, the chief executive of Marsh & McLennan Cos. After Mr. Spitzer accused Marsh's insurance brokerage of bid-rigging, its board forced out then-CEO Jeffrey Greenberg, Mr. Greenberg's son and a former AIG executive. Mr. Cherkasky, the head of Marsh's investigative unit, became the new chief.

When he came in, a criminal indictment of the company remained a possibility. But Mr. Cherkasky cleaned house among the company's high ranks, then made sure the firm's internal investigation and cooperation with regulators were the top priority. He often personally participated in talks with regulators.

Bob Jensen's threads on insurance company scandals are at http://www.trinity.edu/rjensen/FraudRotten.htm#MutualFunds

Bob Jensen's threads on PwC woes are at http://www.trinity.edu/rjensen/fraud001.htm#PwC


An investing balloon that will one day burst
The numbers are mind-boggling: 15 years ago, hedge funds managed less than $40 billion. Today, the figure is approaching $1 trillion. By contrast, assets in mutual funds grew at an impressive but much slower rate, to $8.1 trillion from $1 trillion, during the same period. The number of hedge fund firms has also grown - to 3,307 last year, up 74 percent from 1,903 in 1999. During the same period, the number of funds created - a manager can start more than one fund at a time - has surged 209 percent, with 1,406 funds introduced in 2004, according to Hedge Fund Research, based in Chicago.
Jenny Anderson and Riva D. Atlas, "If I Only Had a Hedge Fund," The New York Times, The New York Times, March 27, 2005 --- http://www.nytimes.com/2005/03/27/business/yourmoney/27hedge.html 
Jensen Comment:  The name "hedge fund" seems to imply that risk is hedged.  Nothing could be further from the case.  Hedge funds do not have to hedge risks,  Hedge funds should instead be called private investment clubs.  If structured in a certain way they can avoid SEC oversight.  
See "Hedge Fund" at http://www.trinity.edu/rjensen/acct5341/speakers/133glosf.htm#H-Terms 

Remember how the Russian space program worked in the 1960s? The only flights that got publicized were the successful ones.  Hedge funds are like that. The ones asking for your money have terrific records. You don't hear about the ones that blew up. That fact should strongly color your view of hedge funds with terrific records.
Forbes, January 13, 2005 --- http://snipurl.com/ForbesJan_13 

Actions speak louder than words
When the Taiwanese President, Chen Shui-bian, visited the Solomon Islands last week, he held a media conference in which he denied that his nation used "chequebook diplomacy" to gain recognition in the region. Then the local journalists attending were handed gifts of watches and MP3 music players.
"Questions of corruption in the search for Pacific allies," Sydney Morning Herald, February 7, 2005 --- http://www.smh.com.au/text/articles/2005/02/06/1107625061638.html 

Corruption Scandal in France
Senior allies of President Jacques Chirac -- including four former ministers -- were among nearly 50 people who appeared in court in Paris at the start of one of France's biggest ever political corruption trials.  A total of 47 defendants -- including politicians, party officials, and representatives of some of France's biggest building companies -- are accused of fixing public works contracts in the Paris region in order to obtain illegal party funding.  One of several financial scandals to come to light from Chirac's long tenure to 1995 as mayor of Paris, the affair centres on kickbacks worth more than 70 million euros (93 million dollars) allegedly paid by the building firms in order to secure bids to renovate secondary schools around the capital.  Under a secret arrangement that lasted from 1989 to 1997, companies funnelled back two percent of the money paid by the regional Ile-de-France council, with 1.2 percent going to Chirac's Rally for the Republic (RPR) and its ally the Republican party (PR), and 0.8 percent going to the Socialists (PS), according to the prosecution.
"Chirac allies among 47 accused in major French corruption trial," AFP, March 21, 2005 --- http://story.news.yahoo.com/news?tmpl=story&cid=1511&e=5&u=/afp/20050321/wl_afp/francejusticepolitics_050321142150 

Ebbers Found Guilty
Former WorldCom Chief Executive Bernard J. Ebbers was convicted of participating in the largest accounting fraud in U.S. history, handing the government a landmark victory in its prosecution of an unprecedented spate of corporate scandals.  After eight days of deliberation, the jury found Mr. Ebbers guilty of all nine counts against him, including conspiracy and securities fraud, related to an $11 billion accounting fraud at the onetime highflying telecommunications giant.  Mr. Ebbers, 63 years old, now faces the prospect of spending many years in jail. He is expected to appeal.
"Ebbers Is Convicted In Massive Fraud:  WorldCom Jurors Say CEO Had to Have Known; Unconvinced by Sullivan," The Wall Street Journal, March 16, 2005; Page A1 --- http://online.wsj.com/article/0,,SB111090709921580016,00.html?mod=home_whats_news_us 
Bob Jensen's threads on WorldCom are at http://www.trinity.edu/rjensen/FraudEnron.htm#WorldcomFraud 

Finding the auditors in the wreckage of a crashed airline
“The jury is going to hear a tale of a very strange, intimate relationship" between Tower and Ernst & Young, said attorney Robert Weltchek of Weiner & Weltchek, arguing on behalf of the creditors in a hearing last week. An Ernst & Young spokesman said, "These charges have no merit, and we will vigorously defend ourselves in court."  Court papers say that Ernst & Young's accounting failures led Tower Air to report a pretax profit of $4.6 million in 1998, when it actually lost about $17 million. And Tower Air's reported $3.9 million loss in 1997 was actually at least $41 million larger, the suit states. It goes on to say that the firm never reconciled Tower Air's payroll account, failed to disclose that Tower Air owed $9 million in back excise taxes, and failed to book $2.75 million of travel agents' commissions as an expense.  Ernst & Young became the airline's independent auditor in 1993. The airline was founded 10 years earlier to fly international routes for government and military officers, but went public in 1993. Ernst & Young had done accounting work for the firm and president Morris Nachtomi since the airline's inception and performed lucrative financial advisory work for the firm since the late 1990s, the suit says.
"Bankrupt Airline Sues Ernst & Young for Accounting Fraud," AccountingWeb, March 16, 2005 --- http://www.accountingweb.com/cgi-bin/item.cgi?id=100673 
You can read more about the legal woes of Ernst & Young at http://www.trinity.edu/rjensen/fraud001.htm#Ernst 

Power goes round and round
At a time when U.S. firms are more reliant than ever on quality accounting and auditing services, the influential Business Roundtable is supporting liability caps for auditors. The Roundtable is worried that the Big Four accounting firms could soon shrink to three or fewer firms if Congress doesn't act to stem the liabilities the firms face when things go wrong.
 
"Business Roundtable Supports Auditor Liability Cap," AccountingWeb, January 18, 2005 --- http://www.accountingweb.com/item/100390 

Three Bank of America Corp. brokerage units agreed to pay $375 million to settle market timing charges, the U.S. Securities and Exchange Commission said Wednesday. The SEC charged that Banc of America Capital Management LLC, BACAP Distributors LLC, and Banc of America Securities LLC entered into "improper and undisclosed agreements" that let favored large investors engage in rapid short-term, market timing and late trading in Nations Funds mutual funds.  Separately, Bank of America's Fleet mutual fund unit agreed to pay $140 million to settle market timing charges, while five former executives were individually charged with market timing violations, the SEC said.
"Bank of America to Settle Mutual Fund Charges," The New York Times, February 9, 2005 --- http://www.nytimes.com/2005/02/09/business/09WIRE-BOFA.html 
Bob Jensen's threads on mutual fund scandals are at http://www.trinity.edu/rjensen/FraudRotten.htm#MutualFunds 

Masters of the Universe
In the late 1990s, CEOs Bernie Ebbers of WorldCom, Dennis Kozlowski of Tyco International, and Richard Scrushy of HealthSouth were what novelist Tom Wolfe called “masters of the universe.” Charismatic, driven and fabulously wealthy, they sat atop giant companies largely of their own making. They didn't so much manage these corporations as reign over them.  But now that their trials for securities fraud are about to begin, they want to let the world in on a little secret: They actually weren't very good at what they did. They were unaware of what was going on around them and were incapable of demanding accountability from their aides. Like the hapless Sgt. Schultz in the old television program Hogan's Heroes, they know nothing, they see nothing.

"The clueless CEO defense," USA Today, January 25, 2005, Page 12A --- http://www.usatoday.com/printedition/news/20050125/edtwo25.art.htm 

Investment Clubs in Action
Hedge funds have long flown under the radar of securities regulators. But with hedge funds managing about $1 trillion, up from about $400 billion just four years ago, and playing a bigger role in the market, regulators have begun to home in.
Gregory Zuckerman and Ian McDonald, "The Wild West Of Hedge Funds Becomes Tamer," The Wall Street Journal, January 24, 2005, Page C1 --- http://online.wsj.com/article/0,,SB110652077260433536,00.html?mod=todays_us_money_and_investing 

Bad Ones Lay Buried In Siberian Snow
Remember how the Russian space program worked in the 1960s? The only flights that got publicized were the successful ones.  Hedge funds are like that. The ones asking for your money have terrific records. You don't hear about the ones that blew up. That fact should strongly color your view of hedge funds with terrific records.

Forbes, January 13, 2005 --- http://snipurl.com/ForbesJan_13 
Bob Jensen's threads on hedge funds can be found by scrolling down at http://www.trinity.edu/rjensen/acct5341/speakers/133glosf.htm#H-Terms 

He's still learning how to dance with the devil
SEC Chairman William Donaldson has quietly made it known to the White House that he would like to remain the nation's top securities cop, but the business lobby would like nothing more than to see him gone.

"Bush's Donaldson Dilemma," by Deborah Solomon and John D. McKinnon, The Wall Street Journal, December 20, 2004, Page A4 --- http://online.wsj.com/article/0,,SB110350099382804351,00.html?mod=home_whats_news_us 
Will Bush be able to stand up to the most powerful people on the planet? --- http://www.trinity.edu/rjensen/fraudRotten.htm#InvestmentBanking 

Business Groups Begin Quiet Campaign to Oust SEC's Donaldson 
AccountingWeb, December 16, 2004 --- http://www.accountingweb.com/item/100230 

Just another day on the fraud beat
The Securities and Exchange Commission slapped Time Warner Inc. with a $300 million fine, its second-biggest fine in history, and issued a stinging rebuke of the company's conduct, capping a three-year investigation into accounting practices at the media titan . . . The SEC yesterday filed a complaint against Time Warner, at the same time it announced the settlement, that charged Time Warner with overstating online advertising revenue and the number of AOL's Internet subscribers, as well as aiding and abetting three other securities frauds. It also charged Time Warner with violating a cease-and-desist order against the America Online division issued in 2000.  "Some of the misconduct occurred while the ink on a prior commission cease-and-desist order was barely dry," said SEC Director of Enforcement Stephen M. Cutler in a statement. "Such an institutional failure calls for strong sanctions."
Julia Angwin, "SEC Fines Time Warner $300 Million," The Wall Street Journal, March 22, 2005; Page A3 --- http://online.wsj.com/article/0,,SB111142076929485150,00.html?mod=todays_us_page_one

SOX Up Boss
A majority of financial executives (57 percent) say Sarbanes-Oxley (SOX) compliance was a good investment for stockholders, according to a report released this month by Oversight Systems, the 2004 Oversight Systems Financial Executive Report On Sarbanes-Oxley Compliance, a nationwide survey of 222 financial executives.

"Financial Execs Call SOX 'Good Investment'," SmartPros, December 22, 2004 --- http://www.smartpros.com/x46291.xml 

In God, but not our financial advisor, we trust!
Declining trust has spurred some 25% of the affluent investors surveyed to move a portion of their assets out of their financial-services firms in the past two years, according to a study by Spectrem Group, a Chicago research and consulting firm. A litany of complaints, including poor investment performance, conflicts of interest, hidden fees and financial scandals, prompted wealthy investors to move their business elsewhere.
Rachel Emma Silverman, "
Wealthy Lose Trust in Advisers," The Wall Street Journal, February 2, 2005, Page D2 --- http://online.wsj.com/article/0,,SB110730662305243216,00.html?mod=todays_us_personal_journal 

Ernst & Young's Chairman and CEO Jim Turley notes in a Wall Street Journal article that Section 404 of the US Sarbanes Oxley Act is a critical step in enhancing investor confidence. He adds that the law entails a major risk in its first year "that the opinions on internal controls provided by management and independent auditors may be misinterpreted by the market." But the bottom line is, "investors will derive significant benefits from the implementation of Section 404. And the markets, in turn, will benefit from the enhanced investor confidence."
E&Y Faculty Connection --- http://www.ey.com/global/content.nsf/International/Home

Lawyers lie?  Can't possibly be true.
Your graph showing that malpractice awards account for only 2% of medical costs is a gross underestimate. The amount juries award to plaintiffs doesn't begin to address the additional tests ordered, extra days in hospitals, extra visits to emergency rooms, or extra meetings -- all performed in the name of reducing litigation. The threat of malpractice, whether legitimate or not, has removed judgment from the practice of millions of physicians. Judgment has been replaced by making sure that no possibility -- no matter how remote -- hasn't been ruled out, requiring billions of dollars of imaging and laboratory tests. Reducing the threat of malpractice to physicians would produce a significant reduction in medical expenditures.  
Jonathan D. Reich, M.D. Assistant Clinical Professor University of Florida School of Medicine Lakeland, Fla. (Dr. Reich is a fellow of American Academy of Pediatrics and a fellow of the American College of Cardiology.)
As quoted from Letters to the Editor, The Wall Street Journal, December 29, 2004, Page A9 --- http://online.wsj.com/article/0,,SB110427584995511487,00.html?mod=todays_us_opinion 

As George Wallace once said:  Avoid pointy-headed professors
The rules that the statute imposes for selection of the members of the committee give no guarantee that the right people will be found to serve onit. Indeed, many eminent professors of accounting cannot serve on audit committees because they do not have the requisite level of practical experience.
Richard Epstein, "In Defence of theCorporation," December 2004 ---  http://www.nzbr.org.nz/documents/publications/publications-2004/in_defence.pdf 
Bob Jensen's threads on corporate governance are at http://www.trinity.edu/rjensen/fraud001.htm#Governance 

J.P. Morgan is facing scrutiny for helping finance hedge fund Canary Capital Partners' improper trading in mutual-fund shares
"SEC Probes J.P. Morgan Role In Canary's Improper Trades," by Tom Lauricella, The Wall Street Journal, December 30, 2004, Page C1 --- http://online.wsj.com/article/0,,SB110435632010212266,00.html?mod=todays_us_money_and_investing 
Bob Jensen's threads on investment banking and mutual fund scandals are at http://www.trinity.edu/rjensen/fraudRotten.htm 
Bob Jensen's threads on derivative financial instruments frauds are at http://www.trinity.edu/rjensen/fraudRotten.htm#DerivativesFrauds 

Please try to understand this math
Investors who are content to pay the average fee for their mutual fund might be surprised to learn that most investors are actually paying quite a bit less.  The average annual fee, expressed as a percentage of fund assets, for the 10,585 open-end stock funds tracked by Lipper Inc. is 1.573%. But the dollar-weighted average fee -- or what the average investor is actually paying -- is a mere 0.936%, according to Lipper.  There is a significant difference because the vast majority of mutual funds aren't the multibillion-dollar portfolios that dominate media coverage, but smaller portfolios that generally have higher so-called expense ratios.
Daisy Maxey, "How to Look at Mutual-Fund Fees," The Wall Street Journal, February 7, 2005, Page R1 --- http://online.wsj.com/article/0,,SB110773891359147341,00.html?mod=todays_us_the_journal_report 

The green Grasso grows all around, all around
Dick Grasso's perks as head of the New York Stock Exchange included a $240,000-a-year secretary, two $130,000-a-year drivers, club memberships and access to a private plane, says a newly released report that paints the Big Board's overseers as oblivious to how much Mr. Grasso earned during his eight-year reign.  The report gives the most detailed public accounting to date of how much Mr. Grasso pocketed during the years in which he was chairman and chief executive, 1995 to 2003 -- about $193 million in annual pay, early pension payouts and estimated interest earned on those payouts.  Relying on compensation experts, the report said that represented upward of $100 million in "excessive" pay. Those figures don't include $48 million in previously accrued benefits that would be due Mr. Grasso under the terms of his last contract.
Aaron Lucchetti and Susanne Craig, "NYSE Report Shows Excesses Under Grasso," The Wall Street Journal, February 3, 2005, Page C1 --- http://online.wsj.com/article/0,,SB110735608008643629,00.html?mod=todays_us_money_and_investing 

Buzzards fatten up on carrion
Professional Fees in Enron Bankruptcy Top $780 million
--- http://www.accountingweb.com/item/100263 
Guess who pays the next time you pay your power bill?
Bob Jensen's threads on the Enron scandal are at http://www.trinity.edu/rjensen/fraudenron.htm#EnronLinks 

The rules that the statute imposes for selection of the members of the committee give no guarantee that the right people will be found to serve onit. Indeed, many eminent professors of accounting cannot serve on audit committees because they do not have the requisite level of practical experience.
Richard Epstein, "In Defence of theCorporation," December 2004 ---  http://www.nzbr.org.nz/documents/publications/publications-2004/in_defence.pdf

Standards for Audit Committees of SEC Registrants --- http://www.hhlaw.com/articles/674_SEC030116_Standards.pdf  Applies to unlisted companies with public debt.

Sarbanes impact on Not-for-Profit organizations --- 
http://snipurl.com/AuditCommitteeRules 
Also see http://www.jaeckle.com/docs/NFP%20Survey%20Report.pdf 

Make Day Traders Act Rationally Rather Than Regulate Hedge Funds 
A groundbreaking study by Stefan Nagel, assistant professor of finance at the Stanford GSB, finds that hedge funds not only failed to create a stabilizing force during the technology bubble of 1998-2000 but instead profitably rode the bubble ---
http://www.gsb.stanford.edu/news/research/finance_hedgefunds_techbubble.shtml 
Bob Jensen's threads on hedge fund scandals are at http://www.trinity.edu/rjensen/fraudRotten.htm 

A penny a day
Thom Calandra, a former columnist for CBS MarketWatch.com, will pay more than $540,000 to settle federal regulators' charges that he used an investment newsletter to pump up the price of penny stocks he owned before selling them.

Eric Dash, "Ex-Columnist Fined in Stock Trading Scheme," The New York Times, January 11, 2005 --- http://www.nytimes.com/2005/01/11/business/media/11tout.html 

It's in their best interest
Some companies are taking weeks to deposit workers' 401(k) contributions, earning interest on the money that should rightfully go to employees. According to MarketWatch, depositing 401(k) deposits can take as long as seven weeks, enough time for employers to earn short-term interest on the period between the deduction and deposit. 

AccountingWeb, January 25, 2005 --- http://www.accountingweb.com/item/100422 

Class Action Securities Fraud Lawsuits up in 2004
While the number of federal securities fraud class actions filed in 2004 increased only moderately from 2003 levels, rising to 212 companies sued from 181, the decline in stock market capitalization corresponding to these actions increased dramatically, according to a report released today by the Stanford Law School Securities Class Action Clearinghouse in cooperation with Cornerstone Research.  The total decline in the market capitalization of the defendant firms from the trading day just before the end of the class period to the trading day immediately after the end of the class period, or the "Disclosure Dollar Loss (DDL)," nearly tripled from $58 billion in 2003 to $169 billion for cases filed in 2004. This 192 percent increase in the DDL index is attributable entirely to eight filings, in which each defendant firm experienced disclosure dollar losses in excess of $5 billion. In sharp contrast, there was only one filing with losses that large in all of 2003.

AccountingWeb, January 6, 2005 --- http://www.accountingweb.com/cgi-bin/item.cgi?id=100321 

Inside Job
Authorities in China have arrested dozens of government officials and bankers accused in a scheme to steal nearly $900 million from the Industrial & Commercial Bank of China, Chinese state media reported.
Andrew Browne, "Arrests Made in ICBC Scandal," The Wall Street Journal, January 18, 2005, Page A6 --- http://online.wsj.com/article/0,,SB110597211289927835,00.html?mod=todays_us_page_one 

Contingent Payment Schemes in the Insurance Industry
A new study found widespread uses of so-called contingent payments to insurance agents for steering customers to certain insurers or for selling policies that generate lower levels of claims.  A new study found widespread use of payments to insurance agents who steer customers to certain home and auto insurers, generating the same potential conflicts as those alleged by New York Attorney General Eliot Spitzer in the commercial-insurance arena.
Judith Burns, "Insurance Agents Steer Consumers To Favored Companies, Study Says," The Wall Street Journal, January 27, 2005, Page D1 --- http://online.wsj.com/article/0,,SB110678244395337299,00.html?mod=todays_us_personal_journal 
Bob Jensen's threads on insurance fraud are at http://www.trinity.edu/rjensen/fraudRotten.htm#MutualFunds 

Putnaming it on the line
Improper share trading at Putnam shortchanged investors by over $100 million, about 10 times a prior estimate, a consultant found.
John Hechinger, "Putnam May Owe $100 Million:  Independent Consultant Finds Improper Trading Cost Investors More Than Previously Believed," The Wall Street Journal, February 2, 2005 --- http://online.wsj.com/article/0,,SB110728870444542645,00.html?mod=home_whats_news_us 
Bob Jensen's threads on mutual fund frauds are at http://www.trinity.edu/rjensen/fraudRotten.htm#MutualFunds 

United Nations (read that United Nepotism)
The UN oil-for-food program chief, under scrutiny for alleged corruption and mismanagement, blocked a proposed audit of his office around the same time he is accused of soliciting lucrative oil deals from Iraq, investigators said. A UN auditing team, which was severely understaffed, said running the $64 billion oil-for-food program was ''a high-risk activity" and a priority for review. But Benon Sevan denied the auditors' request to hire a consultant to examine his office in May 2001.
"Oil-for-food chief said to block audit," Boston Globe, February 13, 2005 --- http://www.boston.com/news/world/articles/2005/02/13/oil_for_food_chief_said_to_block_audit/ 

Fakes!
The global counterfeit business is out of control, targeting everything from computer chips to life-saving medicines. It's so bad that even China may need to crack down
"Fakes," Business Week, February 7, 2005 --- http://snipurl.com/FakesJan_29
Bob Jensen's threads on Fraud Reporting are at http://www.trinity.edu/rjensen/FraudReporting.htm 

More than 230 civilians have been killed while working on U.S.-funded projects in Iraq, and U.S. officials did not properly keep track of $8.8 billion of Iraq's money, according to an inspector general's report released Sunday (January 30).
USA Today, January 31, 2005 --- http://www.usatoday.com/printedition/news/20050131/a_civilians31.art.htm 
I might add that over 300 Iraqi college educators have also been executed, including many who did not necessarily support U.S. presence in Iraq.  Some were killed simply because they were intellectuals who also did not support Islamic fundamentalism and continued suppression of educating women.

Biovail Corp. said the U.S. Securities and Exchange Commission has launched a formal investigation of the Canadian pharmaceutical company's accounting and financial-disclosure practices, upgrading the regulator's informal inquiry started in late 2003.  This company has so many warts," including complex accounting and poor disclosure in recent years and a business model that focuses heavily on one product, depression treatment Wellbutrin XL, said Anthony Scilipoti, executive vice president of Toronto-based Veritas Investment Research. Reports by Mr. Scilipoti and others have in the past criticized Biovail for focusing on earnings excluding various items, capitalizing costs related to acquired products not yet approved for sale, and hard-to-follow acquisitions and product transactions.
Mark Heinzl, "SEC Begins Formal Accounting Probe of Biovail," The Wall Street Journal, March 7, 2005 --- http://online.wsj.com/article/0,,SB111014883344371591,00.html?mod=todays_us_marketplace 
The independent auditor for Biovail is Ernst & Young.

Auto-parts maker Delphi Corp. disclosed multiple accounting irregularities dating back to 1999, including a period when it reported healthy results despite cutbacks in the auto industry, and said a committee of outside directors is investigating the way it accounted for a $237 million payment in 2000 to former parent General Motors Corp., among other transactions. Delphi said it has ousted two executives, including its vice chairman and chief financial officer, Alan S. Dawes, and demoted a third in connection with the board's investigation. Mr. Dawes couldn't be reached to comment.
Karen Lundegaard, "Delphi Discloses Accounting Problems," The Wall Street Journal, March 7, 2005 --- http://online.wsj.com/article/0,,SB110994509329670632,00.html?mod=todays_us_page_one 
The independent auditor for Delphi is Deloitte and Touche.




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

Some of the most notorious white collar criminals in recent history
See History of Fraud in America --- http://www.trinity.edu/rjensen/415wp/AmericanHistoryOfFraud.htm


February 18, 2005 message from Joanne Tweed [ibridges@san.rr.com]

America's seniors are being cheated of their life's savings by securities Broker/Dealers.
SENIORS AGAINST SECURITIES FRAUD http://seniorsagainstsecuritiesfraud.com  offers supportive educational links and solutions. Please consider linking.

Most Sincerely,
Joanne Tweed


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

I’m certain that most of you were overjoyed that you no longer have to pay to track your credit ratings and your FICO scores.  In the past few weeks I’ve stressed the bad things credit card companies are doing with FICO scores and the misleading advertising funded by credit card companies.

Capital One is the worst abuser with misleading advertising and was so noted in a CBS module on 60 Minutes.  Capital One advertises a fixed rate or a variable rate pegged to the prime rate.  But either original rate will more than double with an epsilon increase in your FICO score.  Or as one reporter put it, your Capital One rate will double if you sneeze.  Another Capital One TV advertisement that irks me is the one that promises “no blackout dates” for airline free miles when you use a Capital One card.  Blackout dates are an insignificant problem when cashing in frequent flyer miles.  The problem is that literally all flights have a limited number of seats (usually less than 7% of the seats on any flight) allocated for frequent flyer redemption.  Your Capital One card will not give you priority when fighting for one of the very limited number of seats, but Capital One does not tell you this unless it is in such small print that you couldn’t read it with the Hubble telescope.

 

This is Important

From PBS:  Things a Credit Card Holder Should Know (including online tests for students)

Secret History of the Credit Card --- http://www.pbs.org/wgbh/pages/frontline/shows/credit/ 

You can watch the entire Frontline video from the link on the above site.

Should you get a Capital One credit card?

The point is that credit card companies don't care how rich you are or even your liquidity.  It's your payment practice on all your accounts payable that really counts.  Payment history is the main ingredient of a FICO score, but the actual FICO formula is very complex --- http://www.consumeraffairs.com/finance/fico.html

You're a grade C credit card user if you zero out all your accounts payable in less than 20 days.  Good guys don't get an A or a F grade as credit card customers.  Of course the credit card companies still get a percentage of your purchase prices from the vendors who sold you the goods.  Credit card companies always get something (usually around 6% of the price), but vendors can negotiate the rate they pay on their customers' purchases.  Credit card companies don't care as much for C grade customers because they are limited to the what the product vendors pay one time on each purchase.

You're a Grade B card user if you don't (or can't) pay off your entire monthly balances.  A Grade B customer always pays the minimum balance due on each credit card, but never in his lifetime pays off an entire balance due.   That way the credit card companies collect forever (actually only about 35 years if you don't add to your account) from you in addition to what the product vendor initially paid to them for your purchase.

You're a Grade A customer for Visa if you miss one payment on your Discover card but keep on making all minimum payments on your Visa.  That way Visa can jack up your interest rate from 8.9% to 29.9% APR for the rest of your life because your FICO score increased due to one missed payment on any one of your credit cards or other accounts.  The Frontline show has a segment on how one guy's perfect six-year perfect record of making minimum payments did not prevent his interest rate from jumping up by 20% when it was discovered by the FICO folks that he missed one payment on an account six years in the past.  This is funny (sad?) because this guy’s credit card company’s CEO phoned the guy after the Frontline TV show aired and lowered his rate back down to 8.9%.

It's the indexing of your changing interest rates to your increased FICO score that's the biggest "secret" credit card companies don't want consumers to understand.  The Frontline show ("Secret History of the Credit Card") stresses that most consumers don't even know what a FICO score is let alone how it affects their future interest rates on all their credit card unpaid balances.  See http://www.pbs.org/wgbh/pages/frontline/shows/credit/eight/

The main page for downloading details and the free video of the entire Frontline PBS show is at http://www.pbs.org/wgbh/pages/frontline/shows/credit/ 

How can you beat this scam?
Never pay less than the minimum amount due, control your credit addiction, and try to zero out every credit card balance in less than 20 days or whatever the payment cycle is on your card.  If this fails I would not necessarily advise getting a Capital One card.

Capital One now advertises that the bank has changed its ways and doesn’t change credit card  rates in the same way that other credit card companies are bilking the public ---
http://www.washingtonpost.com/wp-dyn/articles/A8200-2005Jan13.html
I would still advise reading the small print even if it’s a Capital One card.

The Minnesota state attorney general’s office has sued one of the nation's largest credit card issuers (Capital One), claiming it is misleading consumers with promises of “fixed“ interest rates, then hiking their rates as much as 400 percent.
Bob Sullivan, MSNBC, "Capital One Sued Over Marketing Practices," January 3, 2005 --- http://www.msnbc.msn.com/id/6781155/  

January 18, 2004 reply from Linda Kidwell [lak@NIAGARA.EDU]

I have another, totally unrelated reason for not getting a Capital One card. I must say, this story has given me great meat for class discussion in auditing!

When I applied for a mortgage 8 years ago, my credit report contained a three-year-old written-off Capital One card to the tune of $8,000. I had never heard of this card, and it had been issued in my maiden name!

Just think of all the failures of internal controls my case included. At the time the card was issued, they used a marketing list at least three years old to solicit the account. A basic credit check would have revealed that I no longer went by that name, and that in fact I had taken out a mortgage in the past year at a different address. They allowed the perpetrator to run up over $6,000 of charges without having made a single payment. They made no effort to contact me to collect the money, or they'd have discovered the fraud two years earlier. Finally, after I submitted an affadavit to disclaim the account and after they had my credit cleared, they started calling me to collect the debt. Unbelievable!

So will I ever get a Capital One account? NEVER!!!

Linda Kidwell

January 18, 2005 reply from Barbara Scofield [scofield@GSM.UDALLAS.EDU

What do you tell college students about getting store credit cards in order to get the initial 15% discount on merchandise? My daughter gets every credit card Express, Old Navy etc. will give her in order to get the discount and then she cancels the card after the first bill. She feels that she is getting the benefit of the marketing system and none of the costs of having open credit lines count against her (or tempt her).

Barbara W. Scofield, PhD, CPA 
Associate Professor of Accounting 
University of Dallas 
1845 E. Northgate Irving, TX 75062
scofield@gsm.udallas.edu 

January 18, 2005 reply from Richard J. Campbell [campbell@RIO.EDU]

Barbara: She should be concerned about her FICO score. The more inquiries made by department stores, the lower her FICO score will be. The FICO scoring secret algorithms view frequent credit applications a sign of desperation, even if the application is successful.

Q. What are some common missteps that bring down your score?

A. Balance transfers on your credit cards, for one thing. It may seem smart to load all your debt onto one low-rate card. But if you max out on a high-limit card, your credit score takes a big hit. Even if you aren't applying for more credit, your current credit-card companies may raise your interest rates because your credit score dropped.

The whole instant-credit thing also hurts your credit, like when you're at the Gap and they say you get 10 percent off if you apply for a credit card and buy this thing using your new credit card.

You have the combined effect of an "inquiry for new credit" and a small credit limit on the store card, which you already filled up. Both are bad.

The other thing you have to watch out for are collections, the leading type of which is medical collection. Many of those are mistakes -- often an insurance company is responsible for a co-payment, but the doctor bills it to the patient and it ends up becoming a collection.

Richard J. Campbell
School of Business
University of Rio Grande
Rio Grande, OH 45674

January 18, 2004 reply from Roberts, John [JohnRoberts@SJRCC.EDU]

Barbara,

If she lives in Texas she should request her free credit report from all three agencies starting in June. This can be done at http://www.annualcreditreport.com  If she doesn't live in Texas, that site will also tell her when they will be available for her location. She will notice that all of those credit cards are on her report, whether they have a balance or not, whether they are closed or not.

She should then get her FICO score. She will have to pay a small amount for this but it will tell her the score AND what she can do to make it higher. The higher it is the better interest rates you receive on loans from cars to mortgages. If she has been doing what you say, it will most likely report that there have been too many inquiries (like Richard said) and they are lowering her score. It may still be over 700, which seems to be the demarcation line for quick loan acceptance with decent rates but the next inquiry (which she might need for something really important) might drop it below 700 and that would cost her big money (much more than she saved on those department store discounts), especially if it means the difference of a half-point or more on a 30 year mortgage.

College students tend to be very short sighted so this will probably be a big sale on your part -- as you well know. I have two daughters myself which are both out of college now, but still, the only time they listen to ole dad is when they already agree with him and tells them what they want to hear:-)

John C. Roberts, Jr.
Saint Johns River Community College
283 College Drive Orange Park, FL 32065

January 19, 2005 message (re-written by Bob Jensen) from a former high level university administrator

Questions 
Is your university getting credit card kickbacks on student and alumni use of credit cards? 
Did you know that many universities send names, addresses, and social security numbers of students and alumni to a company that solicits them to use a credit card? 

Answer
Many, if not most, colleges and universities are doing this. The reason: every time a credit card is used for any purchase, the university gets a percentage (often ten percent) from the credit card company "as a gift." This kind of income is generally not recognized as a gift by the rules of the college and university auditors/business managers (see NACUBO). Why should the university provide any of this information? In addition to not informing people that this information is being "sold," this practice encourages college students and alumni to go into more debt.

 

A recent academic study compared ratings by Moody's with those of Egan-Jones. William H. Beaver, professor of accounting at Stanford's graduate school of business, Catherine Shakespeare, assistant professor at the University of Michigan Business School and Mark T. Soliman, also at Stanford, analyzed ratings on some 800 companies made by both services from 1997 to 2002.  The academics found that Egan-Jones's ratings changes were more timely than those of Moody's, coming up to six months sooner. The study also found much higher stock returns after rating changes by Egan-Jones than by those of Moody's.  "Using several tests we find that the noncertified firm, EJR is more responsive and closely associated with investors," the study noted.
"Wanted: Credit Ratings. Objective Ones, Please," by Gretchen Morgenson, The New York Times, February 6, 2005 --- http://www.nytimes.com/2005/02/06/business/yourmoney/06gret.html?oref=login  

For years, the nation's credit rating agencies have thrived, booking mouth-watering profits from operations that are riddled with conflicts and shielded from competition.

Soon, however, that may finally change. And investors should be better off for it.

Within the next two months, the Securities and Exchange Commission will press a new regulatory framework for the industry to ensure that debt ratings published by the big three - Standard & Poor's, Moody's Investors Service and Fitch Ratings - are a result of thorough analysis, not a desire for fatter profits.

"I think it's fair to say that the oversight of the industry is insufficient," said Annette L. Nazareth, director of market regulation at the Securities and Exchange Commission. "We want the firms to commit to meet certain standards with respect to policies and procedures on conflicts of interest and solicitation of ratings. Right now we don't have that at all."

Now that would be an upgrade, long overdue. Indeed, given how regulators have attacked conflicts of interest among Wall Street firms, insurance companies and other financial services concerns, it's astounding that the ratings agencies have been allowed to go on this way for so long.

Rating agencies play an enormous role in a huge market. After all, far more debt is issued than stock; last year, corporations issued $1.2 trillion in straight debt versus $146 billion raised in common stock, according to Thomson First Call. An additional $1.4 trillion was issued last year in mortgage debt and asset-backed securities.

All that paper needed a rating before it could be sold to the public. As such, the financial markets rely heavily on the companies that rate them.

Since 1931, for example, the Federal Reserve Board, the Comptroller of the Currency and federal and state laws have regulated the debt held by banks and other financial institutions, using credit ratings assigned to the debt. Pension funds, banks and money market funds are barred from buying debt issues that carry ratings below a certain level.

But not just any rating agency's rating, mind you. In 1975, the S.E.C. ruled that the laws relating to debt carried by banks and financial institutions refer only to ratings provided by agencies that it recognizes. Right now, these are the big three and a much smaller fourth, Dominion Bond Rating Service of Canada.

What you have, in other words, is an oligopoly.

Even more troubling, this oligopoly earns its keep from fees charged to the companies whose debt it rates. This conflicted business model means that the paying customers for these agencies are the corporations they analyze, not the investors who look to the ratings for help in assessing a company's creditworthiness.

Other industry practices also lend themselves to producing less-than-rigorous analysis. For example, rating agencies typically receive the largest fees when they analyze an initial bond issue. After that a nominal fee is levied, providing something of a disincentive to do in-depth, time-consuming work.

And because the nation's courts have ruled that the work of these agencies is opinion and therefore protected by the First Amendment, the big three are protected from lawsuits from investors contending defective analysis. Such lawsuits could act as policing mechanisms.

To make matters worse, these companies have recently begun to expand the services they offer to corporations, leading regulators to fear that ratings could be swayed by revenues earned on other products.

These problems are on the agenda for Tuesday, when Senator Richard C. Shelby, the Alabama Republican who is chairman of the Banking, Housing and Urban Affairs Committee, will hold hearings on the state of the rating agencies. Executives from the big three are scheduled to testify.

This is not the first time that Standard & Poor's, Moody's and Fitch have been in the hot seat. When Enron and WorldCom failed, investors were stunned by how long it had taken the agencies to recognize the companies' declining fortunes. For example, all three agencies had rated Enron an investment-grade company until four days before it filed for bankruptcy. They had rated WorldCom similarly until a few months before it collapsed.

The rating agencies stress that they analyze debt issuers' financial positions to try to predict for investors an entity's ability to pay off its debt. They are not in place to audit auditors, they say, and cannot root out fraud. Their mandate is to provide transparency to the financial market.

IN an interview on Friday, Raymond W. McDaniel, Jr., president of the Moody's Corporation, acknowledged the industry's conflicts but said his company manages them effectively. "We do not link analyst compensation, including bonus compensation, to the ratings they have on the companies they follow or to the amount of fees they receive from those companies," he said. "Beyond that, we have a collection of business conduct policies and codes of practice and behavior which the entire Moody's population is required to adhere to." Top executives at Standard & Poor's, a division of the McGraw-Hill Companies, and Fitch, a unit of Fimalac, were not available for comment, but both companies said they were aware of the potential for conflicts and careful to prevent them.

Increased competition would certainly help investors who are troubled by the conflicts. Unfortunately, companies hoping to break into the ratings game must first earn the all-important designation from the S.E.C. Such nods do not come often.

One upstart concern that has applied unsuccessfully to the S.E.C. is Egan-Jones Ratings, of Philadelphia. It rates approximately 800 companies and had warned of problems at WorldCom, Enron and Global Crossing well before other agencies. Egan-Jones does not accept payment from companies it rates; investors who use its services pay the freight.

A recent academic study compared ratings by Moody's with those of Egan-Jones. William H. Beaver, professor of accounting at Stanford's graduate school of business, Catherine Shakespeare, assistant professor at the University of Michigan Business School and Mark T. Soliman, also at Stanford, analyzed ratings on some 800 companies made by both services from 1997 to 2002.

The academics found that Egan-Jones's ratings changes were more timely than those of Moody's, coming up to six months sooner. The study also found much higher stock returns after rating changes by Egan-Jones than by those of Moody's.

"Using several tests we find that the noncertified firm, EJR is more responsive and closely associated with investors," the study noted.

There is no evidence, of course, that Moody's tardiness is a result of a conflicted business model. And Mr. McDaniel maintains that ratings stability and accuracy are what customers want. "The market has become extremely intolerant of false positives or false negatives, and encouraged the ratings to only be moved when there is not a likelihood that they would be reversed," he said.

But Sean J. Egan, managing director of Egan-Jones, said: "Timely, accurate credit ratings are critical for robust capital markets. Investors, issuers, workers and pensioners will continue to be hurt by the flawed credit rating industry until someone addresses the basic industry problems."

Maybe, just maybe, that process has begun.

February 6, 2005 message from Tom Lechner [lechner@oswego.edu

Thanks for another insightful post.

I assume you mean if your credit score FALLS that Capital One will increase your rate.

Incidentally, MBNA more than doubled my interest rate, even though my score was rising and I never missed a payment.

You say your credit report and score are free. A free credit report is currently only available for those in the west. Those of us in the east have to wait until fall. I do not know of any source of free credit scores. Do you?

Tom Lechner

Dr. Thomas A. Lechner
Dept. Accounting, Finance & Law 
SUNY - Oswego Oswego, NY 13126

You can read more about conflicts of interests in credit rating agencies at http://www.trinity.edu/rjensen/FraudRotten.htm#CreditRatingAgencies 

Bob Jensen's threads on the dirty secrets of credit card companies are at http://www.trinity.edu/rjensen/FraudReporting.htm#FICO 


February 17, 2005 message from David Coy [dcoy@adrian.edu

Bob:

Here's a link to an article on identity theft and fraud from today's Washington Post.

David Coy 
Adrian College

*******************************

The message is ready to be sent with the following file or link attachments: Shortcut to: http://www.washingtonpost.com/wp-dyn/articles/A30897-2005Feb16.html?referrer=email 


"Few companies have to tell when identity thieves strike:  Consumers don't learn they're in danger — until the bills arrive," USA Today, February 28, 2005 --- http://www.usatoday.com/printedition/news/20050228/edit28x.art.htm 

The Federal Trade Commission (FTC) received 246,570 identity theft complaints last year, and the problem actually is much worse: 9.9 million people (about one in every 30 Americans) were victims of identity theft in a one-year period starting in spring 2002, according to an FTC survey. Thieves use the data to get credit cards, pilfer bank accounts and take over identities for future thefts.

Several factors give them the upper hand:

•Companies hide break-ins. Many companies react as ChoicePoint did initially. They keep quiet after computers are hacked, fearing lawsuits and damaged reputations.

•Police are busy elsewhere. Local police are often reluctant to pursue cases. The amounts, while large to an individual, seem small compared with other monetary crimes. Often the consumer lives in one state, the thief in another. Federal authorities can act, but only about 1 in 700 cases of identity theft resulted in a federal arrest in 2002, according to Avivah Litan, a cybercrime expert with the Gartner research firm.

•Oversight is weak. Identity theft is a relatively new crime and, outside of California, governments haven't yet geared up to address it. The rising industry of data brokers has little oversight, and rules for financial institutions aren't up to the task.

The good news is that the ChoicePoint breach is prompting several states, including Georgia, New Hampshire, New York and Texas, to consider bills patterned on the California notification law. Several U.S. senators are pushing a federal law.

Continued in article

Bob Jensen's threads on phishing are at http://www.trinity.edu/rjensen/ecommerce/000start.htm#SpecialSection 

Bob Jensen's threads on Identity Theft --- http://www.trinity.edu/rjensen/FraudReporting.htm#IdentityTheft




"MBIA Announces Plan To Restate Its Earnings:  Big Insurer's Move Is Tied To Avoidance of Losses; Second Firm to Take a Hit," by Theo Francis, The Wall Street Journal,  March 9, 2005; Page C3 --- http://online.wsj.com/article/0,,SB111030063373073552,00.html?mod=home_whats_news_us 

MBIA Inc. will restate more than six years of its financial statements in a move acknowledging that it wrongly used a complex insurance transaction in 1998 to reduce losses on bonds it insured, the company said.

The announcement makes MBIA the second major insurer this year to announce a restatement tied to faulty accounting for complex insurance products they themselves used, following in the heels of Bermuda-based RenaissanceRe Holdings Ltd.

Bob Jensen's threads on insurance company frauds are at http://www.trinity.edu/rjensen/fraudrotten.htm 
MBIA is audited by PricewaterhouseCoopers LLP.  You can read more about PwC's woes at http://www.trinity.edu/rjensen/fraud001.htm#PwC 


Accounting usually gets them in the end
Remember the SCO mouse that roared when suing IBM and Linux

SCO says it missed the filing deadline over issues relating to the accounting of its common stock and equity compensation plan. As a result of adjustments to its accounting, SCO will be restating its earnings for the first three quarters of 2004, BusinessWeek has learned. While the restatements won't change its net loss or cash balance for that year, they are likely to reduce its cash position by $500,000 or more in fiscal year 2005, says an insider. . . What once looked like a mortal threat to Linux appears to be fading. As a result, the suit has become a nonfactor in corporate buying decisions. "I can't imagine how this will go anywhere," says Alex Dietz, chief information officer at Acxiom, a Little Rock consumer-data-analysis company that uses Linux.
"A Linux Nemesis on the Rocks SCO's lawsuit is floundering -- and now the struggling software company faces regulators' scrutiny and questions about its management," Business Week, March 3, 2005 --- http://www.businessweek.com/technology/content/mar2005/tc2005033_4497_tc119.htm 
Jensen Comments
The independent auditor for SCO is KPMG.
A SCO Versus IBM Website is at http://sco.iwethey.org/ 


From The Wall Street Journal Weekly Accounting Review on March 4, 2005

TITLE: Little Campus Lab Shakes Big Firms 
REPORTER: Diya Gullapalli 
DATE: Mar 01, 2005 
PAGE: C3 
LINK: http://online.wsj.com/article/0,,SB110964409606666696,00.html  
TOPICS: Cash Flow, Financial Accounting

SUMMARY: The Georgia Institute of Technology's Financial Analysis Lab issued a report "chastising dozens of companies...for treating customer-related loans as an 'investing' activity rather than an 'operating' one" in their statements of cash flows. Based on this report, the SEC sent letters to "about a dozen companies" requiring them to correct this classification for 2004 and two previous years in order to present comparable data on the face of the financial statements. The SEC as well requires disclosing the impact of the change and to explicitly state that the SEC required the companies to undertake the correction.

QUESTIONS: 

1.) Define the terms operating cash flows, investing cash flows, and financing cash flows, on the basis of the items that should be included in each of these sections of the statement of cash flows.

2.) Define at least one use of the amount of operating cash flow in ratios used for financial statement analysis.

3.) Is the subtotal for operating cash flows more important than the sub-total for investing cash flows? Why or why not?

4.) What is the nature of the items that were misclassified by Ford Motor Company and General Motors Corp.? How could these companies have argued that their treatment was appropriate?

5.) Is it likely that transferring these items into the operating cash flow section of the statement of cash flows will continue to have a negative impact on the amount of these companies' operating cash flow into the foreseeable future? Why or why not?

Reviewed By: Judy Beckman, University of Rhode Island


This is Auditing 101:  Where were the auditors?

"SEC Uncovers Wide-Scale Lease Accounting Errors," AccountingWeb, March 1, 2005 --- http://www.accountingweb.com/cgi-bin/item.cgi?id=100600 

Where were the auditors? That is the question being asked as more than 60 companies face the prospect of restating their earnings after apparently incorrectly dealing with their lease accounting, Dow Jones reported.

Companies in the retail, restaurant and wireless-tower industries are among those affected in what is being called the most sweeping bookkeeping correction in such a short time period since the late 1990s.

Among the companies on the list are Ann Taylor, Target and Domino's Pizza. You can view a full listing of the affected companies.

"It's always disturbing when our accounting is not followed," Don Nicolaisen, chief accountant at the Securities and Exchange Commission, said last week during an interview. He published a letter on Feb. 7 urging companies to follow accounting standards that have been on the books for many years, Dow Jones reported.

Based on the charges and restatement announcements that have come in the wake of the SEC letter it seems companies have failed for years to follow what regulators see as cut-and-dried lease-accounting rules. The SEC has yet to go so far as to accuse companies of wrongdoing, but it has led people to wonder why auditors hired to keep company books clean could have missed so many instances of failure to comply with the rule.

"Where were the auditors?" J. Edward Ketz, an accounting professor at Pennsylvania State University, said to Dow Jones. "Where were the people approving these things? This doesn't seem like something that really requires new discussion. If we have to go back and revisit every single rule because companies and their professional advisers aren't going to follow the rules, then I think we're in very serious trouble in this country."

Tom Fitzgerald, a spokesman for auditing firm KPMG, declined to comment. Representatives for Deloitte & Touche LLP, PricewaterhouseCoopers LLC, and Ernst & Young LLP, didn't return several phone calls, Dow Jones reported.

The crux of the issue is that companies are supposed to book these "leasehold improvements" as assets on their balance sheets and then depreciate those assets, incurring an expense on their income statements, over the duration of the lease. Instead, companies such as Pep Boys-Manny Moe & Jack had been spreading those expenses out over the projected useful life of the property, which is usually a longer time period, Dow Jones reported.

As a result, expenses were deferred and income was added to the current period. McDonald's Corp. took a charge of $139.1 million, or 8 cents a share, in its fourth quarter to correct a lease-accounting strategy that it says had been in place for 25 years, Dow Jones reported, adding that Pep Boys said it would book a charge of 80 cents a share, or $52 million, for the nine months through Oct. 30, 2004.

Bob Jensen's threads on lease accounting are at http://www.trinity.edu/rjensen//theory/00overview/theory01.htm#Leases 

Bob Jensen's threads on bad auditing are at http://www.trinity.edu/rjensen/FraudConclusion.htm#IncompetentAudits 


"PwC, Partners Hit with Class-Action Pension Suit," AccountingWeb, March 1, 2005 --- http://www.accountingweb.com/cgi-bin/item.cgi?id=100599 

A former PricewaterhouseCoopers LLC employee has instigated a class-action suit against the Big Four firm claiming unfair pension practices, Pension and Investments reported.

In the suit filed in federal district court in East St. Louis was amended on Jan. 28 and charges PwC and its partners with coming up with “a brazen, unlawful scheme ... to game the tax and pension laws in order to improperly pad the partners' retirement benefits and take-home pay at the expense of both rank-and-file PwC employees and the public,” Pension and Investments reported.

The suit was brought by former employee Timothy D. Laurent and contends that the firm, which has been known for it's creative cash-balance pension funds, intentionally broke age- and income-discrimination provisions of federal law.

By “engaging in multiple layers of deception,” the suit alleges, PwC and its partners reduced “benefits to the paid rank-and-file employees down to the bare minimum thought need(ed) to keep the shelter afloat.”

While federal pension law shields employers from liability for the investment performance of participants' 401(k) plan options, it does not apply to defined benefit plans, Pension and Investments reported, meaning that a ruling in favor of Laurent and other participants could cost the firm hundreds of millions of dollars.

Continued in article

Bob Jensen's threads on PwC legal woes are at http://www.trinity.edu/rjensen/fraud001.htm#PwC 


"Nonprofit that Collapsed Amid Scandal Sues Accounting Firm," AccountingWeb, February 23, 2005 --- http://www.accountingweb.com/cgi-bin/item.cgi?id=100569 

A San Francisco nonprofit that went out of business after failing to account for $19 million in donations is suing its auditor.

The suit, filed by PipeVine's court-appointed receiver, seeks unspecified damages as a "result of the acts, omissions and breach of duty by defendant Grant Thornton,” according to the San Francisco Business Times. The complaint go on to say that "in its oral and/or written reports or statements, defendant Grant Thornton made untrue and/or misleadingly incomplete representations or failed to state material facts." PipeVine was a spinoff organization of United Way of the Bay Area, which was audited by Grant Thornton. It became a stand-alone organization in 2000 and annually processed more than $100 million in donations. It closed operations in 2003 after it was discovered that some donations directed to charities actually went to PipeVine's day-to-day operations.

Grant Thornton, in an e-mail to the San Francisco Business Times, said the suit “is without merit and will be vigorously fought.” The firm argues that it recommended that PipeVine's management investigate the fact that PipeVine was overspending donations collected for charities. That was in January 2003. The firm later suspended audit work after meeting with the board of directors.

Continued in article

Bob Jensen's threads on Grant Thornton's woes are at http://www.trinity.edu/rjensen/fraud001.htm#GrantThornton 


Fannie Mae is a great source for students learning about breakdown of internal controls

From The Wall Street Journal Accounting Weekly Review on March 11, 2005

TITLE: Fannie Regulator Tightens Its Grip 
REPORTER: James R. Hagerty 
DATE: Mar 09, 2005 
PAGE: A3 
LINK: http://online.wsj.com/article/0,,SB111030895766973673,00.html  
TOPICS: Accounting, Information Technology, Internal Auditing, Internal Controls, Regulation

SUMMARY: "Fannie Mae's regulator told the mortgage company to fix 'deficiencies' in accounting-ledger and corporate-records controls. The new requirements include policies bhannien falsified signatures on journal entries and limiting employees' ability to alter databases." The internal control framework developed by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) is used as a basis for questions. For those instructors who wish to refer their students to the executive summary for this framework, it is available on the web at http://www.coso.org/Publications/executive_summary_integrated_framework.htm The Institute for Internal Auditors publishes a checklist developed by COSO which is available on the web at

http://www.theiia.org/?doc_id=374 

QUESTIONS: 
1.) Define internal control and provide a proper reference to your source for that definition.

2.) What is COSO? Who or what comprises the members of COSO?

3.) What professional documents identify the basis for sound internal controls? Who establishes these standards?

4.) What internal control violations are highlighted in this article? Name each and describe the component of control being violated, based on COSO's five components of internal control.

5.) How does automation, and technical staff access to databases, add to issues inherent in systems of internal control?

6.) Compare the discussion of internal controls in the main article to the related article. How are the issues in the main article regarding internal controls consistent with problems that are identified in the related article as the basis for denying hedge accounting treatment for derivatives?

7.) Refer to the comparison made in answer to question 6. What general category or categories of internal control do you think were ultimately violated at Fannie Mae? Do you think this violation stems from the internal control environment at Fannie Mae? Support your answer.

Reviewed By: Judy Beckman, University of Rhode Island

--- RELATED ARTICLES --- 
TITLE: Fannie Faces Billions in New Losses 
REPORTER: Jonathan Weil and James R. Hagerty 
PAGE: A3 
ISSUE: Mar 03, 2005 
LINK: http://online.wsj.com/article/0,,SB110980084894668645,00.html 

"Fannie Mae Is Cited for 'Deficiencies':  Regulator Sets Conditions To Correct Internal Controls; Office of Compliance Created," by James R. Hagerty, The Wall Street Journal, March 9, 2005; Page A3 --- http://online.wsj.com/article/0,,SB111030895766973673,00.html 

Fannie Mae's regulator announced that it has instructed the mortgage company to correct "deficiencies" in its controls over accounting ledgers and other corporate records.

The new requirements include the adoption of policies banning falsified signatures on accounting journal entries and limiting employees' ability to alter database records.

The latest move by the regulator -- the Office of Federal Housing Enterprise Oversight, or Ofheo -- illustrates its tightening grip on Fannie in light of an accounting scandal that emerged last year.

Fannie's board also agreed to create an "office of compliance and ethics" and to direct the company's general counsel to inform directors and regulators of "actual or possible misconduct" at the company.

The directions to the company's board and management are included in an agreement with the regulator, signed by Fannie Mae's interim chairman, Stephen B. Ashley, and released by Ofheo yesterday. The specificity of the agreement suggests that Ofheo has found examples of Fannie employees flouting some basic standards of conduct.

An Ofheo spokeswoman declined to say whether such wrongdoing had been found but said the regulator continues to work closely with the Justice Department and the Securities and Exchange Commission in investigating Fannie's accounting and internal controls.

Rep. Richard H. Baker (R., La.), chairman of a House subcommittee that oversees Fannie and its smaller rival, Freddie Mac, said the agreement "raises many disturbing questions, especially about tampering with records, and we need to know the nature of the records and the extent of this outrageous practice." He scheduled a hearing for April 5 to look into the matter.

Mr. Ashley said in a statement that the agreement "represents the next step in Fannie Mae's cooperative effort to address issues raised by Ofheo." A spokesman declined to elaborate.

At a minimum, Fannie seems to have allowed "extreme sloppiness" in its internal controls, said Karen Petrou, a managing partner at Federal Financial Analytics Inc., a research firm in Washington.

The new agreement supplements one imposed on Fannie last September by Ofheo in the wake of findings that Fannie violated accounting rules in an attempt to smooth out fluctuations in its earnings. Those findings, backed by the SEC's chief accountant, prompted Fannie's board in December to oust the company's chief executive officer and chief financial officer.

Until recently, Fannie had the political clout to brush off concerns raised by Ofheo, but the accounting scandal has forced the company to seek a far more cooperative relationship with its regulator.

Among other things, the agreement requires Fannie to devise a plan for rectifying "deficiencies" in procedures for making and revising accounting journal entries. Those entries must be "supported by appropriate documentation," the agreement says.

In addition, Fannie agreed to "adopt appropriate internal controls" on any "overwriting" of database records by technical-support employees at the direction of management to make changes or corrections. Those changes would have to be properly documented.

The agreement also notes that Fannie's board has separated the functions of chairman and chief executive, formerly both held by Franklin D. Raines, who was forced to step down in December. Under Mr. Raines, Fannie resisted Ofheo's proposal for a regulation that would, among other things, require that the two jobs be held by different people. That proposed regulation has been held up for months by a review at the Office of Management and Budget; one person familiar with the situation said the Bush administration was reluctant to set policy on whether companies should combine the two functions. But Ofheo now has used its growing clout to persuade both Fannie and Freddie to separate the jobs, even without a regulation.

Continued in article

"Fannie Faces New Accounting Issues," by James R. Hagaerty, The Wall Street Journal, February 24, 2005, Page A3 --- http://online.wsj.com/article/0,,SB110916481988961983,00.html?mod=todays_us_page_one 
KPMG was fired as Fannie's auditor.  Deloitte is the new auditor for Fannie Mae.  Deloitte & Touche assisted OFHEO in its work on assessing Fannie Mae's accounting practices.

Regulator Raises Questions On Securities Bookkeeping; Capital Plan Is Approved 

Fannie Mae disclosed that its main regulator has found evidence of possible further violations of accounting rules at the mortgage company.

The giant mortgage-finance company, still reeling from earlier findings that it broke accounting rules, declined to estimate the possible effect on earnings of these new issues. But Josh Rosner, an analyst at Medley Global Advisors, an investment-research firm in New York, said the latest disclosures illustrate that many of the company's problems "are still ahead, not behind."

Fannie also said it will "sharply curtail" its corporate advertising and use of lobbyists as part of a drive to rebuild its capital in the wake of losses on derivatives contracts used to hedge interest-rate risks.

The company's regulator, the Office of Federal Housing Enterprise Oversight, or Ofheo, has approved Fannie's plans to boost capital and has given the company more time to do so, Fannie said. Ofheo has ordered Fannie to raise its capital to a level 30% higher than the ordinary minimum by Sept. 30. That represents a three-month extension from the original timetable set by Ofheo after it reported accounting violations by the company last September.

Correcting those violations will require Fannie to recognize an estimated $9 billion of losses on derivatives that otherwise would have been spread out over many years. The company is working on a restatement of its results for the past four years. That process, being conducted by a new auditor, Deloitte & Touche LLP, "may result in additional adjustments, perhaps material adjustments," to past and current financial results, Fannie warned.

Continued in article

From The Wall Street Journal Weekly Accounting Review on January 7, 2005 

TITLE: 
Fannie Mae to Select Deloitte to Succeed KPMG as Auditor 
REPORTER: Jonathan Weil 
DATE: Jan 05, 2005 
PAGE: B3 
LINK: Print Only 
TOPICS: Auditing, Auditing Services, Auditor Changes, Auditor Independence

SUMMARY: Fannie Mae's financial statements have been found to contain material misstatements, primarily due to inappropriate accounting for derivatives, and it has selected a new auditor. The original assessment of inappropriate accounting was made by the Office of Federal Housing Enterprise Oversight (OFHEO) and was confirmed by a Securities and Exchange Commission (SEC) ruling last month. Deloitte & Touche assisted OFHEO in its work on assessing Fannie Mae's accounting practices.

QUESTIONS: 
1.) Why is Fannie Mae selecting a new auditor? Describe the events leading up to this change. In your answer, describe the purpose of Fannie Mae and briefly explain how it operates. (You may refer to the related article to develop your answer to this question.)

2.) Was Fannie Mae clear in describing its reasons for selecting this audit firm? Explain. What were the probable reasons that Fannie Mae chose Deloitte and Touche to serve as its next auditor?

3.) Why are the number of firms from which Fannie Mae could choose to serve as auditor so small? What do you think is the impact of the few number of large public accounting firms on the auditing profession?

4.) Do you think that Fannie Mae could choose from among more firms than those that are discussed in the article? From the perspective of any audit firm, describe the business risks associated with taking on the Fannie Mae audit.

5.) How would you describe the nature and extent of the audit procedures the Deloitte and Touche audit team will undertake in their work on Fannie Mae's financial statements? Explain your answer in terms of auditing standards associated with these issues, such as those associated with proper engagement planning and risk assessment.

Reviewed By: Judy Beckman, University of Rhode Island

--- RELATED ARTICLES --- 
TITLE: Fannie's Dismissal of KPMG Shows Dwindling Choices Among Big Four 
REPORTER: Jonathan Weil 
PAGE: C1 ISSUE: Dec 23, 2004 
LINK: http://online.wsj.com/article/0,,SB110374574788607414,00.html 

Bob Jensen's threads on Fannie Mae are at http://www.trinity.edu/rjensen/caseans/000index.htm 


Question
First there's a problem of simply accepting something by word of mouth.  Second there is a problem of accepting the word of mouth of an executive with an obvious conflict of interest.  Is this acceptable auditing procedure?  

"Tyco Auditor Raised, Dropped Bonus Disclosure, Witness Says," by Chad Bray, The Wall Street Journal, February 18, 2005, Page C3 --- http://snipurl.com/TycoFeb18  

NEW YORK -- Tyco International Ltd.'s former head of finance testified yesterday that the company's lead auditor initially raised concerns that Tyco didn't disclose millions of dollars in relocation-loan forgiveness and other payments to top executives L. Dennis Kozlowski and Mark H. Swartz in 2000.

However, Mark D. Foley, the conglomerate's former senior vice president of finance, said PricewaterhouseCoopers partner Richard Scalzo dropped his objections after Mr. Foley told him that Mr. Swartz had consulted outside lawyers who concurred the bonuses didn't need to be in the proxy because they were associated with relocation loans. Mr. Foley said he had raised similar concerns to Mr. Swartz, Tyco's then-chief financial officer.

"Rick was OK" with it, Mr. Foley said in response to a question by Assistant District Attorney Marc Scholl.

Prosecutors claim that Messrs. Swartz and Kozlowski, Tyco's former chief executive, granted themselves millions of dollars in unauthorized bonuses and other compensation, including $48 million in loan forgiveness and other payments in connection with the initial public offering of its optical-fiber unit Tycom in 2000.

Messrs. Kozlowski, 58 years old, and Swartz, 44, are on trial in New York state court. They have denied wrongdoing. Their first trial ended in a mistrial in April. Tyco has its headquarters in Bermuda, but now operates out of West Windsor, N.J.

Continued in article


This is a good, albeit controversial, article that CEOs won't want to read.

"'SOX' It To Them," by Paul Schaafsma, Financial Engineering News --- http://www.fenews.com/fen41/law_and_fe/law_and_fe.html# 

Despite these and other drawbacks, with compliance around the corner the sky has not fallen. While admittedly expensive to implement, examination of some of the claims CEOs have made about the cost of compliance leaves one scratching his head. One publicly traded company with $300,000 in earnings estimated that it would cost $250,000 to comply and is therefore de-listing. Earnings of $300,000? What about the other costs of being a publicly traded company? Further, several companies with less than $4 billion in revenues have predicted that more than 20,000 staff hours are needed to comply; however, a well-respected company with more than $35 billion in revenues estimates it will need 5,000 staff hours to comply. Just what may have been going on before that now requires 20,000 hours to address? And with information technology consultants, law firms and accounting firms attacking the compliance issue as a business opportunity on par with Y2K, many companies are simply spending too much.

In addition to making companies more transparent and executives more accountable, many companies will reap additional benefits. For example, many companies have multiple business units with varying standards of financial reporting. Smart companies have used compliance as an opportunity to get a standardized financial reporting system in place across a company’s business units.

And like a residual benefit of the Y2K scare, many companies have updated and standardized their company’s finance software to help in the compliance process. In addition to minimizing the chance and therefore the costs of a compliance issue, the operational benefits of having standardized, updated financial software will accrue cost savings long into the future. Moreover, smart companies have used their need to update their financial reporting software as an opportunity to upgrade and standardize additional software, such as their ERP systems.

Continued in the article


"Number of Firms That Switched Auditors Jumped 78% in 2004," by Diya Gullapalli, TheWall Street Journal, February 17, 2004, Page C3 --- http://snipurl.com/AuditSwitch 

More than 1,600 companies changed outside auditing firms last year, a 78% jump from 2003, according to a research report released yesterday by proxy-advisory firm Glass Lewis & Co.

The total of 2,514 for the two years represents more than one-fourth of publicly listed companies in the U.S., according to databases of public companies.

Small companies changed auditors most: Of those switching, 85% posted $100 million or less in revenue last year, the report said. Of the companies that disclosed reasons for the switch, the top ones included audit firms discontinuing public-client work because of extra regulatory demands, corporate mergers and lower fees at the new firm.

The high turnover disclosed by the report has some implications for a long-standing debate in the corporate-governance world about whether investors would be better served by mandatory auditor rotation. While the Sarbanes-Oxley corporate governance legislation of 2002 requires that certain audit partners rotate away from their clients every five years, there currently isn't a rule stipulating that the audit firm itself must rotate. However, the high frequency of switches suggests that audit committees are taking it upon themselves to do so anyway. The increased changes are "inconsistent with the arguments put forth in the past by the accounting firms, that changing auditors reduced audit quality," research analyst Jason Williams said in the report.

The report also found that, while small audit firms originally complained about the passage of the Sarbanes-Oxley act because it created more financial-reporting requirements, they are reaping the benefits as the Big Four's smaller clients turn to them.

The switches helped second-tier audit firms in particular. These firms had a net gain of 117 clients last year while the Big Four -- Deloitte & Touche LLP, Ernst & Young LLP, KPMG LLP and PricewaterhouseCoopersLLP -- had a net loss of 400 clients. Of all accounting firms, BDO Seidman LLP chalked up the most wins with 109 new clients, while Ernst & Young lost the most clients with 200 dropping the firm last year.

A total of 61 companies, most of them with annual revenue of less than $25 million, changed auditors at least twice last year, in what the report dubs "opinion shopping" to get desired accounting treatment. The report also found that 30% fewer companies, or 19, switched auditors last year because of disagreements over accounting matters. However, of the companies changing auditors, there were 30 that restated financial statements, more than twice as many as in 2003.

Some companies did not choose to switch auditors, but they discovered they had no choice!

Some CPA Offices Can't Get Their SOX Up!

"Sorry, the Auditor Said, but We Want a Divorce," by Lynnley Browning, The New York Times, February 6, 2005 --- http://www.nytimes.com/2005/02/06/business/yourmoney/06audit.html 

Howard Root, chief executive of Vascular Solutions, got a jolt in September as he was preparing his company for a routine examination by Ernst & Young, the Big Four firm that had been its auditor since it was founded in 1997. Without warning, and less than three months before Vascular's annual report was due at the Securities and Exchange Commission, Ernst & Young quit.

But why? Mr. Root said that there were no financial improprieties or deteriorating prospects at Vascular Solutions, a medical devices maker based in Minneapolis. In fact, he said, the company had just reported record sales and shrinking losses. The company had no disagreements with Ernst & Young, he said.

Rather, Mr. Root said, Ernst & Young told him that it didn't have enough people to handle the mountain of extra work created by the Sarbanes-Oxley corporate watchdog act - especially for smaller clients like Vascular Solutions, which had net sales of around $20 million last year. The Sarbanes-Oxley law, passed in 2002, tightens accounting procedures and imposes new reporting rules on publicly traded companies and their outside auditors.

The timing of Ernst & Young's resignation was like "being served with divorce papers with no notice," Mr. Root said. "If you're going to get dropped," he added, "it's usually for the next year's work." A spokesman for Ernst & Young declined to comment.

. . .

The top auditing firms, collectively known as the Big Four, declined to say how much more the new law was costing their clients, though they all said it had sharply increased the amount of work they must do for clients, and the fees they charge. BDO Seidman, a so-called second-tier firm, says its fees have increased by 40 percent to 100 percent, if it agrees to retain the client at all.

John J. O'Connor, a vice chairman of PricewaterhouseCoopers, the nation's largest auditor based on revenue, said his firm had "raised the bar, made it a higher hurdle" in terms of how it decided to retain clients or take on new ones. Mr. O'Connor declined to say how many clients his firm dropped last year but said the reduction from July 2003 to June 2004 totaled 660,000 client hours, a single-digit percentage decrease.

James S. Turley, chairman and chief executive of Ernst & Young, testifying about Sarbanes-Oxley before a Senate committee last September, painted an image portraying some clients as ripe for divorce in the new risk-averse era.

"Our client acceptance and reacceptance processes," he said, according to a transcript, "have been re-engineered with an increased focus on determining which companies we really want as audit clients and culling out those that we do not believe have adapted to the new environment and demands on a public company." An Ernst & Young spokesman later said that the firm resigned from 88 clients last year, compared with 52 in 2003.

Only recently, the Big Four seemed willing to work with just about any corporate client - big or small, poky or fast-growing, publicly traded or private. But as more accounting scandals unfold, auditors are increasingly choosy about the companies they keep. No auditor wants to go the way of Arthur Andersen, which collapsed after it was convicted of obstruction of justice over its work for Enron. Arthur Andersen is appealing that verdict to the Supreme Court.

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


February 7, 2005 message from Taylor, Eileen [etaylor@COBA.USF.EDU

Some companies are choosing to "go dark" or delist from the major stock exchanges because they can't afford to comply with Sarbanes-Oxley. Not exactly the result Congress was looking for... I imagine that even with good strong internal control, the documentation and compliance costs are just too high to justify remaining on the exchange.

Either way, the effect will be less transparency, rather than more. I also don't expect the stockholders to be overjoyed at voluntary delisting.

See article from the January 30, 2005 New York Times: Why Companies Delist... "...about 200 companies petitioned to delist their stocks in 2003, and he estimates that a similar number did so in 2004. In 2002, 67 companies went dark."

Looks like it would make an interesting study.

Eileen 
University of South Florida 
Eileen Taylor
etaylor@coba.usf.edu 


"Report Criticizes KPMG, Banks Committee urges expanded probe of tax-shelter abuses," Elliott Blair Smith, USA Today, February 14, 2005

Senate investigators urged federal regulators Thursday to expand a probe of abusive tax shelters to the banking and securities industries after finding that a few accounting and law firms had shared $275 million in fees from the products' sale to wealthy investors.

Estimating Treasury losses from the shelters at more than $85 billion over the last decade, the Senate Permanent Subcommittee on Investigations said it backs legislation to compel the IRS to share confidential taxpayer information with other federal agencies.

Last week, the Bush administration proposed to increase the IRS's enforcement budget by 8%, equal to more than $400 million. IRS spokesman Terry Lemons credited Senate investigators with ''groundbreaking work.'' He declined to comment on the panel's proposal to make the IRS share taxpayer returns.

''Any time you talk about information sharing between the IRS and anybody else, it's going to raise red flags,'' Taxpayer Notes reporter Allen Kenney said.

Senate aides said the egregiousness of the abuses the panel identified would propel reforms.

Many of the alleged abuses surfaced previously during the panel's three-year investigation, but the 141-page final report contains damaging new details.

In particular, investigators criticized the KPMG audit firm, two law firms and several investment banks, saying they worked together to promote shelters that featured paper losses and sham charitable contributions.

Investigators said KPMG made more than $124 million by aggressively marketing the deeply flawed shelters to wealthy investors while taking ''steps to conceal its tax-shelter activities'' from federal tax authorities.

KPMG allegedly paid the law firm known now as Sidley Austin Brown & Wood $23 million to provide supportive legal opinions on more than 600 shelters. It allowed one former Sidley Austin lawyer, R.J. Ruble, to bill it at the equivalent rate of $9,000 an hour.

In turn, KPMG allegedly referred many of its shelter clients to another law firm, Sutherland Asbill & Brennan, for legal defense work while failing to disclose it had paid the law firm nearly $14 million for unrelated work. Investigators said they found evidence that Sutherland Asbill shared with KPMG details of confidential discussions the lawyers had with the IRS.

When shelter clients asked about suing the auditor, the lawyers declined to help, without stating why, investigators said. One Sutherland Asbill attorney told his client, ''I need to duck my head in the sand on these,'' according to his notes, contained in the report.

KPMG spokesman George Ledwith said the firm ''regrets its participation'' in the now-discredited tax shelters and cited ''fundamental changes that KPMG vigorously undertook in its tax practice.'' In January 2004, the firm replaced three top tax executives. It also dismantled much of its shelter business. It remains subject to a federal grand jury probe and civil lawsuits.

Sidley Austin officials in New York and Washington did not return a reporter's phone calls.

Sutherland Asbill managing partner James Henderson issued a statement that the firm ''respectfully disagrees'' with the panel's conclusions. He said the firm advised clients of the potential conflict of interest regarding KPMG.

Senate investigators also criticized Deutsche Bank, HVB Bank, UBS and the former First Union National Bank, now part of Wachovia Bank, for advancing more than $15 billion in credit to KPMG tax-shelter clients.

It said Deutsche Bank earned $44 million, First Union $13 million and HVB $5.45 million for financing shelters the banks knew posed ''reputational risk.''

Investigators particularly criticized KPMG and the banks for working together when the firm audited the banks' books. The report says KPMG knew the relationship ''raised auditor-independence concerns,'' concluding that the firm was ''auditing its own work.''

KPMG says it "regrets its participation" in four tax shelters studied by a Senate subcommittee, which on Thursday released new details about how the accounting firm developed and sold the products being investigated. http://www.accountingweb.com/item/100520 

In a statement Thursday, KPMG said that while the new report "acknowledges cultural, structural and institutional changes to KPMG's tax practices" in recent years, KPMG "nevertheless regrets its participation in them." KPMG spokesman George Ledwith said “them” referred to the four tax shelters examined by the subcommittee in late 2003. The Justice Department and the Internal Revenue Service are investigating KPMG, which is cooperating.

The new report also said that the $10 billion Los Angeles Department of Fire and Police Pensions and the $400 million Austin Fire Fighters Relief and Retirement Fund in Texas participated in more than half of KPMG's 58 deals for SC2 from 1999 to 2002.

The above paragraphs are quoted from the body of the article.

Bob Jensen's threads containing further details on this KPMG scandal are at http://www.trinity.edu/rjensen/fraud001.htm#KPMG 


And to those who think SOX is a waste of time and money!
Note that Kodak's auditor is PwC!

From The Wall Street Journal Accounting Weekly Review on February 4, 2005

TITLE: Kodak to Get Auditors' Adverse View 
REPORTER: William M. Bulkeley and Robert Tomsho 
DATE: Jan 27, 2005 
PAGE: A3 
LINK: http://online.wsj.com/article/0,,SB110674149783836535,00.html  
TOPICS: Auditing Services, Internal Controls, Sarbanes-Oxley Act, Auditing

SUMMARY: "Kodak joins a growing list of corporations reporting [material internal control weaknesses] under new Sarbanes-Oxley rules that went into effect in November."

QUESTIONS: 
1.) What are the Sarbanes-Oxley requirements for auditors to provide reports on internal controls? How did that expand internal control work previously done for financial statement audits of publicly traded companies? (Hint: to answer questions 1 and 2, you may refer to on-line summaries of Sarbanes-Oxley requirements by the AICPA and the SEC at http://www.aicpa.org/info/sarbanes_oxley_summary.htm  and

http://www.sec.gov/news/press/2003-66.htm 

2.) Under Sarbanes-Oxley, who else besides auditors must report on publicly-traded companies' internal control systems?

3.) The author defines the term "material weakness in internal control" and then states that the disclosure of a material weakness isn't evidence that a misstatement in financial reporting actually has occurred. How can this be the case?

4.) Given that Kodak must have exhibited this internal control weakness in the past, what must have been the effect on audit procedures undertaken on the Kodak audit engagement?

5.) Compare and contrast the types of auditor's reports on internal control that are to be issued for Kodak and for SunTrut Banks, Inc. That is, based on the description in the article, how do you think these reports will differ?

Reviewed By: Judy Beckman, University of Rhode Island

"Kodak to Get Auditors' Adverse View," by William M. Bulkeley and Robert Tomsho, The Wall Street Journal, January 27, 2005, Page A# --- http://online.wsj.com/article/0,,SB110674149783836535,00.html 

Eastman Kodak Co. released preliminary fourth-quarter results in line with expectations, but said its auditors are expected to issue an "adverse opinion" citing "material weaknesses" in its internal financial controls for 2004.

Kodak joins a growing list of corporations reporting such problems under new Sarbanes-Oxley rules that went into effect in November. Earlier this month, SunTrust Banks Inc., Atlanta, said it will disclose a material weakness in its annual report. Last month Toys "R" Us Inc. disclosed that it was working to resolve unspecified internal-control issues.

so-called material weakness is a deficiency in record-keeping that is deemed likely to result in a misstatement of financial results. However, the disclosure of a material weakness isn't evidence that such a misstatement has actually occurred.

Kodak, of Rochester, N.Y., posted a preliminary fourth-quarter loss, reflecting restructuring costs and said revenue grew 3% as digital-product sales increasingly offset declines in film. Executives promised improved results this year.

In 4 p.m. New York Stock Exchange composite trading, Kodak stock was up 11 cents at $31.66 a share, as investors seem to be looking beyond the accounting issues because of emerging signs of the company's success in new imaging technology.

Kodak said that it is only able to report preliminary results because it discovered errors in its accounting of taxes for plant closings outside the U.S. It said it expects to report final results on schedule in its annual 10-K filing with the Securities and Exchange Commission in March, although it isn't clear whether any restatements of prior periods will be required.

Chief Financial Officer Robert Brust, meeting with investors in New York, said Kodak expects to strengthen financial controls by then, but said it expected the adverse PricewaterhouseCoopers opinion in any case. PricewaterhouseCoopers didn't return phone calls seeking comment on Kodak.

Amid more scrutiny of corporate bookkeeping, securities lawyers and accounting concerns expect the number of companies reporting such problems to grow. In an interview with Dow Jones Newswires from an economic forum in Switzerland yesterday, PricewaterhouseCoopers Chief Executive Samuel DiPiazza said he expected about 10% of U.S. companies to report that they either have material weaknesses or can't certify that their internal-control procedures are sound in time for their 2004 annual reports.

Such troubles are expected to be particularly widespread among smaller companies whose financial systems are newer and less refined. "The scuttlebutt in the Valley is that up to half of the companies could flunk," says Boris Feldman, a Palo Alto, Calif., securities lawyer whose firm represents a number of technology concerns in Silicon Valley.

For the quarter, Kodak reported a net loss of $12 million, or four cents a share, compared with net income of $19 million, or seven cents a share, in the year-earlier period. Revenue rose 3.2% to $3.77 billion from $3.65 billion.

Continued in the article

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


"SEC Steps Up Effort to Fight Stock Fraud," by Deborah Solomon, The Wall Street Journal, February 2, 2005, Page D1 --- http://online.wsj.com/article/0,,SB110729717180142868,00.html?mod=todays_us_personal_journal 

The Securities and Exchange Commission, trying to head off potential stock-fraud schemes before investors get hurt, has started to halt trading in companies whenever illicit stock touting is suspected.

The move is part of the agency's broader attempt to get ahead of possible fraud before it becomes widespread. Over the past week, the SEC temporarily suspended trading in two companies when regulators believed a campaign to artificially inflate the price of shares was under way. The agency is expected to suspend trading in several other companies within the coming weeks and months, according to people familiar with the matter.

On Monday, the SEC halted trading in Commanche Properties Inc., a Tucson, Ariz.-based motion-picture company, and last week halted trading in Courtside Products Inc., a family-run business in Spokane, Wash., that sells sporting-equipment bags. In both cases the companies were listed on the pink sheets -- where small stocks are traded over the counter -- but hadn't registered as public companies. The trading suspensions last for 10 days. A phone call to Commanche wasn't returned.

At issue is the potential for so-called pump-and-dump schemes, whereby speculative investors, company insiders or others try to inflate demand for a stock by trumpeting positive-sounding information about a company -- typically via e-mail -- and then cash in their shares at the higher price. Often the information is false and the stock quickly declines again.

Continued in the article

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


The following message was sent to students in one of my classes this semester.  I might add that for background understanding of derivative financial instruments, I’ve not seen a better elementary text than the following

Derivatives:  An Introduction by Robert A Strong, Edition 2 (Thomson South-Western, 2005, ISBN 0-324-27302-9)

The course syllabus is at http://www.trinity.edu/rjensen/acct5341/acct5341.htm#Preliminary1

You might find the links sent by one of my students (Chris) interesting.

*****************************************

In answer to a question from Chris, the best explanation of Enron’s secret use of derivatives is in Frank Partnoy’s testimony before the Senate (which is not assigned reading for this course, but very interesting reading nevertheless) --- http://www.trinity.edu/rjensen/FraudEnron.htm#FrankPartnoyTestimony
One of the things that caused Enron to implode was the secret use of over 3,000 SPEs (now called VIEs by the FASB) and derivatives (particularly put options) in those SPEs.  One of the project task forces will enlighten us about older SPE rules versus new Interpretation 46 VIE rules.  My threads on this are at http://www.trinity.edu/rjensen//theory/00overview/speOverview.htm

My threads on the Enron/Andersen scandal are at http://www.trinity.edu/rjensen/FraudEnron.htm
There is too much here to assign in Acct 5341, but it makes for interesting reading.

Chris sent the following message:

-----Original Message-----
From: Hendrix, Christopher
Sent: Sunday, January 23, 2005 8:11 PM
To:
Jensen, Robert
Subject: Articles, presentation date list

Dr. Jensen,

I have a couple links you might find interesting, was just trying to do a little more background reading on derivatives. 

http://www.reason.com/0402/fe.gc.in.shtml (I thought it was a fairly good intro article to derivatives and possible uses)

http://www.fenews.com/fen26/enron2.html (discusses how derivatives were involved with and used by Enron)

Also, would you happen to have any links to other good sites about how Enron used derivatives?  I knew they were using SPE's to hide their debt but never really realized they were using derivatives as well to mask their troubles, with derivates seemingly unfairly blamed for their part.  So it was interesting reading that they used price swaps etc with their SPE's, and I was wondering if you had some other handy links about how this was done. 


Small Change:  A Billion Here, A Billion There

"Bremer can't account for $11.6 billion, audit shows," by T. Christian Miller, The New York Times, February 1, 2005

The US-led provisional government in charge of Iraq was unable to properly account for nearly $US9billion ($11.6 billion) in Iraqi funds it was charged with safeguarding, a scathing audit report reveals.

The Coalition Provisional Authority (CPA) may have paid salaries for thousands of non-existent "ghost employees" in Iraqi ministries, issued unauthorised multimillion-dollar contracts, and provided little oversight of spending in possibly corrupt ministries, according to the report by Stuart Bowen, the special inspector-general for Iraq reconstruction.

"While acknowledging the extraordinarily challenging threat environment that confronted the CPA throughout its existence and the number of actions taken by CPA to improve the [interim Iraqi government's] budgeting and financial management, we believe the CPA management of Iraq's national budget process and oversight of Iraqi funds was burdened by severe inefficiencies and poor management," concludes the report, which was released yesterday.

In a letter to Mr Bowen, the authority's former administrator, Paul Bremer, blasted findings of a draft copy of the report, saying it was filled with "misconceptions and inaccuracies".

Mr Bremer acknowledged that financial systems in Iraq were weak, but said Mr Bowen failed to take into account the US mandate to quickly turn over control to an Iraqi government.

The authority disbanded after handing over power to the interim Iraqi government last June.

A Pentagon spokesman also disagreed with the report, saying the authority had implemented reforms to improve accountability.

"The CPA was operating under extraordinary conditions from its inception until mission completion," said the spokesman, Bryan Whitman. "Throughout, the CPA strived earnestly for sound management, transparency, and oversight."

The audit report adds to a growing body of evidence that the US-led occupation government created a two-tier system of oversight that continues to severely hamper the rebuilding of Iraq. US taxpayer funds received relatively close scrutiny. Iraqi money stemming from oil revenues and assets seized from the regime of Saddam Hussein, however, were spent without controls designed to ensure accountability.

The report also found that at least 232 civilians had been killed while working on US-funded contracts in Iraq and the death toll was rising rapidly.


"Insurance Broker Settles Spitzer Suit for $850 Million," by Joseph B. Treaster, The New York Times --- http://www.nytimes.com/2005/02/01/business/01marsh.html?oref=login 

Marsh & McLennan Companies, the largest insurance broker in the world, agreed yesterday to pay $850 million to settle a lawsuit accusing it of cheating customers by rigging prices and steering business to insurers in exchange for incentive payments.

Although Marsh did not formally acknowledge any wrongdoing, Michael G. Cherkasky, the chief executive, apologized for what he called the "shameful" and "unlawful" behavior of "a few people" at the company. But he added, "We don't believe that our corporate entity has ever been involved in a pattern of covering up or a pattern of criminal behavior."

The $850 million, which Marsh will pay over a four-year period, will be used to compensate about 100,000 corporations and smaller businesses whose commercial insurance it arranged from 2001 to 2004.

Continued in article

Bob Jensen's threads on insurance frauds are at http://www.trinity.edu/rjensen/fraudRotten.htm#MutualFunds 


"Beyond The Balance Sheet Earnings Quality," by  Kurt Badanhausen, Jack Gage, Cecily Hall, Michael K. Ozanian, Forbes, January 28, 2005 --- http://www.forbes.com/home/business/2005/01/26/bbsearnings.html 

It's not how much money a company is making that counts, it's how it makes its money. The earnings quality scores from RateFinancials aim to evaluate how closely reported earnings reflect the cash that the companies' businesses are generating and how well their balance sheets reflect their true economic position. Companies in the winners table have the best earnings quality (they are generating a lot of sustainable cash from their operations), while companies in the losers table have been boosting their reported earnings with such tricks as unexpensed stock options, low tax rates, asset sales, off-balance-sheet financing and deferred maintenance of the pension fund.

Krispy kreme doughnuts is the latest illustration of the fact that stunning earnings growth can mask a lot of trouble. Not long ago the doughnutmaker was a glamour stock with a 60% earnings-per-share growth rate and a multiple to match-70 times trailing earnings. Now the stock is at $9.61, down 72% from May, when the company first issued an earnings warning. Turns out Krispy Kreme may have leavened profits in the way it accounted for the purchase of franchised stores and by failing to book adequate reserves for doubtful accounts. So claims a shareholder lawsuit against the company. Krispy Kreme would not comment on the suit. 

Investors are not auditors, they don't have subpoena power, and they can't know about such disasters in advance. But sometimes they can get hints that the quality of a company's earnings is a little shaky. In Krispy's case an indication that it was straining to deliver its growth story came three years ago in its use of synthetic leases to finance expansion. Forbes described these leases in a Feb. 18, 2002 story that did not please the company. Another straw in the wind: weak free cash flow from operations. You get that number by taking the "cash flow from operations" reported on the "consolidated statement of cash flows," then subtracting capital expenditures. Solid earners usually throw off lots of positive free cash flow. At Krispy the figure was negative.

 Is there a Krispy Kreme lurking in your portfolio? For this, the fifth installment in our Beyond the Balance Sheet series, we asked the experts at RateFinancials of New York City ( www.ratefinancials.com ) to look into earnings quality among the companies included in the S&P 500 Index. The tables at right display the outfits that RateFinancials puts at the top and at the bottom of the quality scale. The ratings are to a degree subjective and, not surprisingly, some of the companies at the bottom take exception. General Motors feels that RateFinancials understates its cash flow. But at minimum RateFinancials' work warns investors to look closely at the financial statements of the suspect companies. 

A lot of factors went into the ratings produced by cofounders Victor Germack and Harold Paumgarten, research director Allan Young and ten analysts. A company that expenses stock options is probably not straining to meet earnings forecasts, so it gets a plus. Overoptimistic assumptions about future earnings on a pension fund artificially prop up earnings and thus rate a minus. A low tax rate is a potential indicator of trouble: Maybe the low profit reported to the Internal Revenue Service is all too true and the high profit reported to shareholders an exaggeration. Other factors relate to discontinued operations (booking a one-time gain from selling a business is bad), corporate governance (companies get black marks for having poison pills), inventory (if it piles up faster than sales, then business may be weakening) and free cash flow (a declining number is bad).

Continued in this section of Forbes

Bob Jensen's threads on accounting theory are at http://www.trinity.edu/rjensen//theory/00overview/theory01.htm 

Especially note the core earnings module at http://www.trinity.edu/rjensen//theory/00overview/theory01.htm#CoreEarnings 

For details see  http://www.trinity.edu/rjensen//theory/00overview/CoreEarnings.htm 


KPMG Gets Hammered Again

As the World Economic Forum got under way in the Alpine resort of Davos, Switzerland, critics of globalization handed out "Public Eye Awards" for irresponsible corporate behavior.
"Critics Give 'Public Eye' Awards for Corporate Irresponsibility," AccountingWeb, February 1, 2005 ---  http://www.accountingweb.com/item/100440 

As the World Economic Forum got under way in the Alpine resort of Davos, Switzerland, critics of globalization handed out “Public Eye Awards” for irresponsible corporate behavior. According to Agence France-Presse, Nestle, oil giant Shell and Dow Chemicals, as well as Wal-Mart and KPMG International, were criticized as being among the worst corporate performers from 20 multinational nominees that have allegedly failed in their responsibilities regarding human rights, labor relations, the environment or taxes.

“They are model cases for all the corporate groups that have excelled in socially and environmentally irresponsible behavior. They reveal the negative impacts of economic globalization,” the organizers of the Public Eye on Davos, said in a statement, AFP reported. The nonprofit groups behind the awards are Berne Declaration and Pro Natura Friends - Friends of the Earth Switzerland.

Protests coincided with the start of the annual World Economic Forum, which the Canadian Press termed a “schmooze-fest” for 2,000 top corporate executives, political leaders and celebrities from around the world. The theme for this year's forum is “Taking Responsibility for Tough Choices.”

Nestle won the “most blatant case of corporate irresponsibility” Public Eye award for its marketing of baby foods along with a labor conflict in which it allegedly fired all the staff at a factory in Colombia, replacing every employee with cheaper labor.

The award for the human rights category went to Dow Chemicals, which was nominated for its role in the Bhopal chemical disaster of 1984. About 50 Greenpeace activists lay on the street, dressed in skeleton suits to bring attention to the 20,000 victims of the world's worst chemical disaster.

Shell, meanwhile, was awarded the environment prize for its “numerous oil spills” in the Delta region of Nigeria, according to Ethical Corporation magazine.

Other award winners include Wal-Mart, which was chosen for allegedly allowing poor working conditions in its African and Asian factories, and the professional services firm KPMG for promoting "agressive tax avoidance."

KPMG, which is based in 148 countries, was nominated by the Tax Justice Network. A spokesman for the campaign said: "Many tax practitioners earn huge fee income from developing tax avoidance strategies and promoting them to corporate clients."

A spokeswoman for KPMG International said that the allegations were "misleading and inaccurate,” according to the Guardian of London. She added: "We have not provided the tax practices at issue for a number of years."

KPMG's sales of $1 billion possibly illegal tax shelters is documented (complete with the Frontline PBS video) at http://www.trinity.edu/rjensen/fraud001.htm#KPMG 


Just a Typical Day on the Fraud Beat
A Houston investment fund, which started as a promising money- maker for a group of wealthy, well-connected acquaintances, has ended in a Texas district court with accounting firm KPMG on the hot seat. http://www.accountingweb.com/item/100455 February 3, 2005

Well, Not Quite Typical to This Extreme
Former E&Y Audit Partner Jailed for SOX Violations
Late last year, Thomas Trauger (Ernst & Young) pled guilty to falsifying records in a federal investigation in violation of the Sarbanes-Oxley Act. He admitted as part of this plea that he knowingly altered, destroyed and falsified records with the intent to impede and obstruct an investigation by the Securities and Exchange Commission. http://www.accountingweb.com/item/100445 

Bob Jensen's threads on the legal woes of large CPA firms are at http://www.trinity.edu/rjensen/fraud001.htm#others February 3, 2005


"Ernst & Young Is Sued Over Advice On CA Purchase of Software Firm," by William M. Bulkeley, The Wall Street Journal, February 15, 2005; Page A14 --- http://online.wsj.com/article/0,,SB110843854004254956,00.html?mod=home_whats_news_us 

Texas software entrepreneur who headed Sterling Software Inc. when it was sold to Computer Associates International Inc. in March 2000 filed suit against Ernst & Young LLP, which had audit relationships with both companies in the $4 billion transaction.

In his suit, filed in Texas District Court in Dallas, Sam Wyly claims he relied on Ernst & Young's audit of Computer Associates' books for fiscal 1999, which ended March 31, in making his decision to sell the company for Computer Associates stock. Barely a month later, the shares fell 12% in one day when the company delayed reporting year-end earnings, and later that year the stock declined again when Computer Associates failed to make the earnings it had forecast.

Computer Associates, a maker of enterprise software systems based in Islandia, N.Y., is emerging from a $2.2 billion accounting scandal that led to the indictment of its former chief executive, Sanjay Kumar, in September and the resignations and indictments of several other top officials. Mr. Kumar has pleaded not guilty to charges related to the company's financial problems. Computer Associates has admitted to backdating contracts and keeping its books open days after they were supposed to be closed on the last day of a quarter, in order to book extra revenue.

Continued in the article

Bob Jensen's threads on the lawsuit and SEC woes of Ernst & Young are at http://www.trinity.edu/rjensen/fraud001.htm#Ernst 

Bob Jensen's threads on bad audits are at http://www.trinity.edu/rjensen/FraudConclusion.htm#IncompetentAudits 


"These Stock Options Just Didn't Add Up," by Grechen Morgensen, The New York Times, January 30, 2005 --- 

Top executives on the receiving end of munificent pay packages like to argue that their troughs full of stock options have no relationship to the improprieties that keep erupting across corporate America.

But an episode last week involving Brocade Communications, a San Jose, Calif., company that makes switches for computer storage networks, suggests that every now and again there just might be a connection after all.

Back in the bubble of 2000, you may recall, Brocade Communications was one heck of a stock. The shares went public in May 1999 at a split-adjusted $4.75. By October 2000, the stock had climbed to $133. It closed on Friday at $5.99.

Last Monday, after the stock market closed, Brocade announced that its board had appointed a new chief executive to replace Gregory L. Reyes, its longtime chief; that it would be restating its results for the last six fiscal years; and that its annual financial report would not be filed on time to the Securities and Exchange Commission.

Other than that, the company said, everything's going great.

Financial restatements are distressingly common, of course. But Brocade certainly wins a prize for having to recompute its results for every one of the six years that it has existed as a public company.

The amounts being restated are considerable. In fiscal 2004, for example, Brocade's net loss swelled to $32 million from $2 million as a result of the restatement. For 2003, its loss grew to $147 million from $136 million, and in 2002, its net income rose to $126 million from $60 million as a result of the new computations.

The restatements, the company said, all had to do with errors in its option accounting. After a review, the audit committee of Brocade's board concluded that the company must record additional compensation charges relating to option grants from 1999 through the third quarter of 2003. What's more, the committee found "improprieties in connection with the documentation" of option grants given to a small number of employees before mid-2002 and concluded that the company's documentation related to certain option grants before August 2003 was unreliable.

Exactly what went wrong with Brocade's options program is not clear; the company is not saying.

An analysis last April by Glass Lewis & Company, an institutional advisory firm, found that Brocade had used unrealistic assumptions in calculating its option expense in its financial footnotes. The assumptions, related to the average life of its options and the underlying volatility in Brocade's stock, wound up understating the true costs of the grants, Glass Lewis said.

Options have been the drug of choice for years at Brocade, as they have been at many Silicon Valley businesses. These companies have fought strenuously against the move last year by accounting rulemakers to require that the costs of this employee compensation be run through the profit-and-loss statement. Along with other companies, Brocade signed a letter to members of Congress in July 2003 that argued against the expensing of options.

As is also typical at technology companies, Brocade's top management, especially Mr. Reyes, have been big recipients of options. In last year's proxy, Brocade noted that 4 percent of the total number of options granted to its employees in fiscal 2003 went to Mr. Reyes.

Brocade's directors also receive stock options as part of their compensation: 80,000 options when they join the board and 20,000 options for each year they remain as members. They also receive annual cash compensation of at least $25,000.

Under a new plan, which Brocade put to a shareholder vote last year, the company proposed a system by which a committee of the board would be free to determine how many options to dispense to directors, when to dispense them, their vesting provisions and terms. "An inflexible compensation structure limits our ability to attract and retain qualified directors," the company noted in its proxy last year. "The board of directors believes that the amended and restated 1999 Director Option Plan is necessary so that we can continue to provide meaningful, long-term equity-based incentives to present and future non-employee directors."

Shareholders shouted down the plan. Fully two thirds of the shares that were voted rejected it.

Many analysts who follow Brocade have concluded that Mr. Reyes's hasty departure was clearly related to the accounting improprieties. But in a conference call on Monday afternoon, David L. House, a Brocade director who is a former chief executive of Allegro Networks and a former president of Nortel Networks, refused to link the two events. Indeed, he told surprised listeners that even though Mr. Reyes would no longer run the company, he would stay on the board and have "a significant and important role" there.

Mr. Reyes has been the body and soul of Brocade practically since the company was born. He became its chief executive in July 1998, before the company went public. He became chairman in May 2001.

But why would Mr. Reyes still have a coveted place on Brocade's board, given the wall-to-wall restatements that occurred on his watch? Leslie Davis, a spokeswoman for the company, wrote in an e-mail message: "Greg has been a key contributor to the success of the company and will still add great value. Greg will advise on strategic and customer issues where he can continue to contribute to the success of Brocade." Ms. Davis declined to make any of the company's directors available.

AT the end of Brocade's last fiscal year, Mr. Reyes had 1.7 million options with exercise prices of either $5.53 or $6.54 each. Ms. Davis said Brocade had not determined whether those options would become immediately exercisable now that Mr. Reyes has, to use the company's expression, passed the baton.

Will the company also continue to reimburse Mr. Reyes for the use of his private plane, as it did when he was chief executive? For fiscal 2002 and 2003, he received $624,000 in such reimbursements. Not determined yet, Ms. Davis said.

Brocade gets some credit for identifying the stock option improprieties. And it has instituted more restrictive policies in its option program recently. But its insistence on keeping Mr. Reyes shows how entrenched the obeisance to chief executives remains at some companies, even among directors who have a fiduciary duty to mind the store.

Obviously, shareholders interested in reforming corporate America have a good deal more work to do.

KMPG was and still is the independent auditor for these "options that just don't add up."

Bob Jensen's threads on incompetent auditing are at http://www.trinity.edu/rjensen/FraudConclusion.htm#IncompetentAudits 

Bob Jensen's threads on KPMG's good news and bad news are at http://www.trinity.edu/rjensen/Fraud001.htm#KPMG 

Bob Jensen's threads on accounting for employee stock options are at http://www.trinity.edu/rjensen/theory/sfas123/jensen01.htm 


Bad audits are so common that multimillion settlements don't even make the front section, let alone the front page.
"Ernst Pays $84 Million to Settle Suit Filed in 1993 by Bank Trustee," by Jonathan Weil and Diya Gullapalli, The Wall Street Journal, January 27, 2005, Page C3 --- http://online.wsj.com/article/0,,SB110679689916037687,00.html?mod=todays_us_money_and_investing 

Ernst & Young LLP agreed to pay $84 million to settle a lawsuit in Boston over its audit work more than a decade ago for the defunct Bank of New England Corp.

The settlement in the long-forgotten case, one of the largest Ernst has made, is a reminder of the litigation pressures on the Big Four accounting firms as they seek to restore public trust in their audit work.

The accord, reached yesterday, came about two weeks after trial proceedings had begun in a federal district court in Boston, and a few days after Douglas Carmichael, chief auditor of the Public Company Accounting Oversight Board, testified in court as the plaintiff's lead expert witness. Mr. Carmichael had been retained as an expert in the suit before he was hired by the accounting board, and the board permitted him to conclude his work.

Ernst denied liability. In a statement, an Ernst spokesman said: "We are pleased to have resolved this issue in a reasonable manner. We believe that it was in the best interest of all parties to resolve this matter to avoid continued litigation and legal costs."

The suit, filed by the bank's bankruptcy trustee in 1993, accused Ernst of malpractice, among other things. Amid pressure from federal banking regulators, who began warning the bank about its deteriorating financial condition in early 1989, the bank in January 1990 announced it would report more than $1 billion in previously undisclosed losses on bad loans for its 1989 fourth quarter. Just four months earlier, the bank had raised $250 million through a public debt offering. The bank filed for Chapter 7 bankruptcy protection in January 1991.

Bob Jensen's threads on the woes of Ernst and Young are at http://www.trinity.edu/rjensen/Fraud001.htm#Ernst 

Bob Jensen's threads on bad audits are at http://www.trinity.edu/rjensen/FraudConclusion.htm#IncompetentAudits


"Elderly Remain Skeptical About Reverse Mortgages," by Kelly Greene, The Wall Street Journal, January 27, 2005, Page D2 --- http://online.wsj.com/article/0,,SB110678384707837356,00.html?mod=todays_us_personal_journal 

Millions of elderly homeowners grappling with poor health could tap billions of dollars through reverse mortgages to help them stay in their homes, but most are reluctant to do so, a new study finds.

Only 13% of older homeowners who were surveyed say they are likely or very likely to use such loans, citing fears of losing their homes or depleting their children's inheritance -- despite the fact that adult children of such homeowners said "that using home equity [to pay for long-term-care needs] was a great idea," says Barbara Stucki, a consultant who led the research effort for the National Council on the Aging, a Washington advocacy group.

In fact, almost two-thirds of the adult children surveyed believe a reverse mortgage can help older people continue to live at home, compared with less than half of older homeowners, the research found.

Two hundred homeowners, half in the 65-plus age group and half between the ages of 35 to 60 with older parents, were interviewed last year. The survey has a 10 percentage-point margin of error.

"It shows what those of us dealing with this in our own families already know -- that the majority of adult children care more about the quality of life of their parents than they do about their inheritance," says Jay Greenberg, the group's executive vice president.

By analyzing 2000 homeownership data collected for the federal Health and Retirement Study, the group found that, overall, 13.2 million households in which the homeowner or the homeowner's spouse was at least 62 years old could qualify for at least $20,000, and $72,128 on average, in reverse-mortgage loans, or a total of $953 billion.

A reverse mortgage lets homeowners who are 62 years old or older borrow against the equity in their property. They can take the proceeds as a monthly check, lump sum or line of credit. So, instead of a homeowner making payments to a bank, as with a traditional mortgage loan, the bank makes payments to the homeowner. The loan is repaid, with interest, when the borrower sells the house, moves or dies. The fees involved are typically 7% to 11% of the home's value.

In 9.8 million of the households that qualified for reverse mortgages, the study found, either the homeowner or the homeowner's spouse already had difficulty with or needed help with personal care or household activities (3.8 million), or suffered from a functional limitation (six million), such as having trouble climbing stairs or carrying groceries.

In fact, people with a functional limitation "are at higher risk of having an accident, like a fall, causing them to need long-term care immediately," Dr. Stucki says. "If they can take out reverse mortgages to help them take preventive measures, that can be a very important group that can benefit."

Instead of being forced to seek government-funded care in a nursing home, families could extract their home equity to pay for long-term care that would be provided directly within their homes -- where the overwhelming majority of elderly people want to receive care, the council contends.

Continued in the article

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


"S.E.C. Gives Foreign Firms Some Hope on New Rules," by Heather Timmons, The New York Times, January 26, 2005 --- http://www.nytimes.com/2005/01/26/business/worldbusiness/26donaldson.html?oref=login 

William H. Donaldson, chairman of the Securities and Exchange Commission, said here Tuesday that the commission was considering tweaking some rules for overseas companies listed in the United States, after an outpouring of foreign criticism of the Sarbanes-Oxley Act.

Mr. Donaldson said that the S.E.C. was also considering making it easier for foreign companies to delist from exchanges in the United States, and that it planned to consider requiring fewer years of past financial statements that comply with United States accounting principles.

The agency would also consider pushing back the deadline for foreign companies to comply with the Sarbanes-Oxley rules on internal controls, Mr. Donaldson said. At present, that deadline is the next annual report that comes after April 15 of this year.

The S.E.C. "remains committed to a level playing field for all its issuers, foreign and domestic alike," Mr. Donaldson said in a speech before several hundred business executives and students at the London School of Economics. "But we recognize that cross-border listings frequently entail issuers having to navigate duplicative or even contradictory regulations."

The S.E.C.'s willingness to consider changes is the first sign that some concessions might be made for foreign companies whose shares are listed in the United States. Since the Sarbanes-Oxley Act was passed in 2002, some overseas companies have been trying to delist from American stock markets and others have opted to list elsewhere because they say the expense of complying with the rules outweighs the benefits.

As a consequence, United States delisting rules have come under fire. According to a rule that dates back decades, companies with 300 or more shareholders in the United States cannot delist their shares from the exchange where they trade. Consequently, they need to comply with Sarbanes-Oxley.

"U.S. federal securities laws and regulations on this issue were designed many years ago," Mr. Donaldson noted, and should be revised to "preserve investor protection without inappropriately designing the U.S. capital market as one with no exit." The S.E.C. is weighing whether there should be a "new approach" for foreign issuers that want to delist, he said.

In addition, the S.E.C. is rethinking how it treats companies listed in Europe that must convert to the European Union's new international foreign reporting standards. In coming months, Mr. Donaldson said he expected the S.E.C. to look at a proposal to allow those using the new European standards to reconcile two years of financial statements to United States accounting principles, instead of three.

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


"KPMG Opens Its Books (a Bit), Offering Glimpse of U.S. Results," by Jonathan Weil, The Wall Street Journal, January 26, 2005, Page C4 --- http://online.wsj.com/article/0,,SB110669725882735997,00.html?mod=todays_us_money_and_investing 

In a break from other large U.S. accounting firms, KPMG LLP offered a peek at its financial results for its most recently completed fiscal year, though it stopped well short of disclosing a complete set of financial statements.

KPMG, the fourth-largest U.S. accounting firm, said it had $4.1 billion in revenue for the year ended Sept. 30, up 8% from a year earlier. The New York-based firm, which is the U.S. affiliate of KPMG International, also reported a 4% decline in profits available for distribution to partners, though it declined to disclose what its fiscal 2004 profits were. Globally, KPMG International said its world-wide affiliates had $13.44 billion of combined revenue for fiscal 2004, up 15% from a year earlier.

Among the factors that weighed on the U.S. firm's earnings were higher litigation costs, including settlements, insurance costs and legal fees. In a statement, Eugene O'Kelly, KPMG LLP's chairman and chief executive, said such costs "as a percentage of revenue across the U.S. accounting profession are running in the double digits, second only to compensation costs, a level that is unsustainable for our profession in the long run."

KPMG, like the other major accounting firms, faces a host of potentially costly lawsuits over its audit work for companies that have disclosed accounting irregularities. Additionally, the U.S. firm's sales of allegedly abusive tax shelters remain the focus of a criminal investigation by a federal grand jury in New York. The firm says it is cooperating with investigators. Last week, KPMG announced that U.S. District Judge Sven Erik Holmes of Tulsa, Okla., 53 years old, will join the firm as its vice chairman of legal affairs, a new position from which he will direct the firm's office of general counsel.

KPMG's decision to disclose its U.S. revenue -- and offer even a directional indication about U.S. profit -- represents a departure from the recent practice at other major accounting firms. Unlike corporations with parent-subsidiary structures, the Big Four accounting firms are structured as loose alliances of independent partnerships that belong to so-called global membership organizations. Generally, their practice has been to announce member firms' combined global revenue, broken down by continent.

"KPMG gains from stricter rules and law changes," by Leon Gettler, Sydney Morning Herald,  January 27 2005 --- http://www.smh.com.au/text/articles/2005/01/26/1106415664712.html 

Tougher rules in Australia and overseas and fatter audit fees have helped push KPMG's global revenue up 14.7 per cent to $US13.44 billion ($17.58 billion) for the year to September 30.

The result shows that the demise of global rival Andersen and the advent of tougher regulations forcing accounting firms to focus on quality audit work have not hampered their growth. Under the new conflict of interest rules, accountants are also picking up non-audit work, such as advisory services and tax, from their competitors' audit clients.

In Australia, KPMG's revenue rose 10.2 per cent to $606 million in the year to June 30, 2004.

More than half came from the Australian firm's audit and risk advisory service, which generated revenue of $346 million, up 10.5 per cent, as corporations called in experts on the international financial reporting standards and the United States' Sarbanes-Oxley Act.

Demand was also driven by Australian companies adjusting to new regulations under the Corporate Law Economic Reform Package (CLERP 9), which includes requirements for chief executives and chief financial officers of listed companies to make declarations that financial reports are in line with accounting standards and are true and fair.

The fatter revenue also reflects increased audit fees. These have been rising as all the big firms, except Deloitte, have sold off their consulting practices to avoid being tainted with accusations of conflicts of interest.

KPMG Australia's chief executive officer, Lindsay Maxsted, said the increased revenue came from a mix of bigger fees and higher demand from risk-averse company boards.

Bob Jensen's threads on the two sides of KPMG are at http://www.trinity.edu/rjensen/Fraud001.htm#KPMG 


Riggs Bank is expected to plead guilty to a criminal charge arising from its services for foreign embassies and rich clients.  Fine Could Hit $18 Million In Money-Laundering Case; PNC Deal's Fate Is Unclear

"Riggs Is Set to Plead Guilty to Crime," by John R. Wilke and Mitchell Pacelle, The Wall Street Journal, January 26, 2005 --- http://online.wsj.com/article/0,,SB110668953418935714,00.html?mod=home_whats_news_us 

Riggs Bank N.A., whose international dealings helped trigger a federal crackdown on money laundering by U.S. financial institutions, is expected to plead guilty to a criminal charge arising from its services for foreign embassies and wealthy clients, including former Chilean dictator Augusto Pinochet.

The Riggs board has been presented with a plea agreement by prosecutors in which the bank would admit to one count of violating the Bank Secrecy Act by failing to file reports to regulators on suspicious transfers and withdrawals by clients, people close to the case said.

Directors are expected to accept the plea and the bank would pay a fine of between $16 million and $18 million. The deal could be announced as soon as tomorrow, these people said.

Continued in the article

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


"Two minutes that shook Europe's bond markets," by Aline van Duyn and Päivi Munter, The New York Times,  September 9, 2005 --- http://www.trinity.edu/rjensen/FraudRottenCitiGroup.htm 

It is likely that Citigroup netted a profit of about €15m - perhaps more depending on the bank's starting position and how much of the trading was done for its proprietary trading book.

The trades' wider repercussions, though, are now becoming clear. The world's biggest bank has raised the hackles of European governments and exposed weaknesses at the heart of the eurozone capital markets. The barrage of criticism from its competitors and customers, and the possibility of action from the FSA, are particularly galling for Citigroup: it has promised to keep its hands clean and set exemplary standards of behaviour following huge fines for malpractice in the US.

Citigroup's gain, of course, was someone else's loss. Big trading banks - ABN Amro, Deutsche Bank, Barclays Capital, JP Morgan Chase, UBS - nursed losses estimated at €1m-€2m. “We were hit, but that happens every once in a while,” said the head of trading at one bank. “Pretty much all's fair in the inter-dealer market and Citigroup spotted a way to make a quick buck. I guess we just have to say well done to them.”

Not everyone saw it that way. Many smaller, local European banks are also signed up as MTS dealers: for these banks a loss of €1m-€2m is more difficult to shrug off. Banks were soon on the telephone to government treasury officials. They, in turn, called Citigroup. “We told Citigroup we didn't appreciate it and felt it was against the spirit of the primary dealer contract,” said an official at a European government treasury. “We feared for the liquidity of our bonds.” Some European governments were clearly furious that the MTS system had been used in such a way. “By some European government treasuries, this trade was perceived as open warfare,” said a head of debt capital markets at a large European bank.

Citigroup had hit upon the weaknesses in a trading system that is at the heart of the borrowing strategies of many European governments. The bank - which counts those same governments among its biggest clients - also touched a nerve within the 5½-year old euro project.

Governments had to cede control over monetary policy to join the single currency. But they fought hard to keep fiscal policy out of the clutches of Brussels. As a consequence, all 12 eurozone countries still borrow in the bond markets for themselves.

The biggest buyers of their debt are local financial institutions such as banks, insurance companies and pension funds. Most are subject to stringent rules that require them to invest heavily in domestic assets - a handy source of money for governments spending more than they earn.

The euro, though, threatened to end governments' access to this easy money. Since financial instruments in at least 10 other countries were now priced in the same “local currency”, an institution in one country could buy bonds issued by other eurozone members with no qualms. Many government treasuries were worried that, if investors piled into German bonds - the benchmark for the whole region - it could cut the liquidity of their bonds and raise borrowing costs.

Take Austria and Germany. Although both countries have top-notch AAA credit ratings, the lower liquidity of Austria's bonds means it must pay more for its debt than Germany: only five-one-hundredths of a percentage point more, but multiplied by many billions of euros borrowed every year, it adds up to extra expense for taxpayers.

To fight back, governments needed to enhance the liquidity of their bonds - and their main weapon was to promote greater electronic trading of their bonds through the MTS system.

MTS, a privatised platform operator created by the Italian treasury to trade domestic government bonds, and which retains close ties to the Italian government, sensed opportunity. Government issuers and banks signed a “liquidity pact” through the MTS system. For banks, this meant agreeing always to trade for certain minimum amounts. Such a quote-driven system is unusual: most electronic trading, and telephone trading, is order-driven. But banks were prepared to subsidise their MTS business by trading unprofitably because European governments, when choosing banks for lucrative business such as derivatives transactions or syndicated bond sales, often picked those that came top of the list in terms of MTS trading volumes.

Continued in the article

Bob Jensen's threads on frauds in banking (including the banning of Citigroup in Japan) are at http://www.trinity.edu/rjensen/fraudRotten.htm#InvestmentBanking 


"Employee fraud worries businesses," Sydney Morning Herald, January 26, 2005 --- http://www.smh.com.au/text/articles/2005/01/26/1106415603314.html 

Australian businesses believe they are more at risk of being ripped off by their employees than by any other method of fraud, a new survey has found.

Robert Half Finance and Accounting said its International Workplace Survey found that 50 per cent of Australian human resources and finance managers felt their staff were a threat to the company's finances.

Other main areas of concern for Aussie businesses were the reporting of financial details (19 per cent), computer crime (nine per cent), and supplier or third party fraud (six per cent).

Robert Half Finance and Accounting's managing director, David Jones, said the impact of fraud on a company's bottom line and reputation was well-known.

"The internal threat of employee fraud in Australia is very real and few businesses can honestly say they have implemented the necessary practices and procedures to examine this issue effectively," Mr Jones said.

However, Mr Jones said the survey, which covered nine countries and 770 finance managers including 74 Australians, also showed 59 per cent of those nationally surveyed had increased controls to detect fraud in the past two years.

He said this was 10 per cent more then the international average.

Mr Jones said the prevention of fraud required businesses to implement appropriate controls and policies.

"Seventy-three per cent of HR and finance managers use internal controls and internal audits to detect fraud, while 30 per cent prefer to use an external auditor," Mr Jones said.

He said once fraud was detected, 37 per cent of the Australians surveyed would investigate - with 31 per cent of these handling the matter internally while 19 per cent chose legal action.


A Citigroup bond trade on Eurex resulted in market manipulation, said Germany's financial regulator, which referred the case to a criminal prosecutor.

"Citigroup Trading Case Is Given to Prosecutor:  German Regulator Decides August Bond Move Resulted In Market Manipulation," by Edward Taylor in Frankfurt and Mitchelle Pacelle in New York, The Wall Street Journal, January 25, 2005, Page C1 --- http://online.wsj.com/article/0,,SB110660720204234515,00.html?mod=home_whats_news_us  By 

Germany's financial regulator said it has found that Citigroup Inc.'s controversial bond trade last August resulted in market manipulation and has referred the case to the public criminal prosecutor in Frankfurt.

The individuals involved could face a fine or jail time, if charged and convicted.

"We have passed on the case to the public prosecutor. There are indications that market manipulation took place in connection with Citigroup's bond trade. The market manipulation took place on Eurex," the futures and options exchange, said Sabine Reimer, a spokeswoman for the regulator known as BaFin.

BaFin declined to discuss the details of its investigation, including how many people were involved, or whether any other companies were involved. German law focuses on prosecuting individuals, not corporate entities.

Yesterday, Citigroup spokesman Daniel Noonan said, "We are disappointed that the BaFin has referred to the prosecutor the question of whether action should be brought against individuals involved in the MTS matter. We will continue to cooperate fully with all authorities reviewing this matter."

The criminal probe comes at a sensitive time for Citigroup. Chief Executive Officer Charles Prince has stated repeatedly in recent months that one of his primary goals is to boost the company's reputation for ethics, which has been battered by a string of regulatory scandals stretching back to its involvement with Enron Corp. and the former WorldCom Inc. (now MCI).

"It's a key priority for this management team to take open issues off the table," he told analysts last week, adding that "it pains me to spend the money to do it." In October, Mr. Prince fired three senior executives over a regulatory scandal in Japan, which resulted in the loss of Citigroup's private-banking license in that country.

BaFin started investigating a trade by Citigroup in October, looking for evidence of potential manipulation of the futures market on Eurex. In August, Citigroup placed €11 billion ($14.36 billion) of sell orders on the bond markets, including the EuroMTS bond-trading platform. As a result, the price of euro-zone government bonds fell, prompting traders to rush to Eurex in an effort to staunch their losses, causing further market disruption. Citigroup eventually bought back some of the bonds, booking a profit.

Citigroup hasn't commented publicly about the status of the bond investigation. In an interview in October, Mr. Prince commented on the controversial trading at the firm's London trading desk. He said "as far as we can tell" the trading wasn't illegal, but he characterized it as "a completely knuckleheaded thing to do." The controversial trading underlined a need to send a strong message to Citigroup traders, he said, that they cannot operate as if they worked for hedge funds and "chew up Citi for your narrow, desk-based interests."

The potential for criminal charges against Citigroup employees is noteworthy. In recent years, Citigroup has settled a number of regulatory probes in the U.S., including a criminal probe in New York by Manhattan District Attorney Robert M. Morgenthau into financings it arranged for Enron. Citigroup employees didn't face criminal charges in any of those cases.

Continued in article

Bob Jensen's threads on derivative financial instruments frauds are at http://www.trinity.edu/rjensen/fraudRotten.htm#DerivativesFrauds 

Bob Jensen's threads on banking scandals http://www.trinity.edu/rjensen/fraudRotten.htm#InvestmentBanking 


"Ex-F.B.I. Agent and Trader Found Guilty in Fraud Case," by Eric Dash, The New York Times, January 25, 2005 --- http://www.nytimes.com/2005/01/25/business/25fraud.html?oref=login 

The guilty verdicts end an unusual trial that invoked the Sept. 11 attacks and provided a rare glimpse into the shadowy world of thinly traded, easily manipulated stocks.

Prosecutors maintained that Mr. Royer, a Federal Bureau of Investigation agent assigned to Indian reservation crimes, provided Mr. Elgindy with information about white-collar corporate investigations. Mr. Elgindy then posted some of that information on his investment Web site, enabling him to collect at least $2.7 million from subscribers. Prosecutors said he also made "thousands of dollars" by trading ahead of those subscribers in some of those stocks, or selling shares short in anticipation that the disclosures about them would send their prices lower.

Prosecutors also said that Mr. Elgindy and his associates threatened to disclose bad news about several small companies unless they were given free or deeply discounted stock.

"Under the guise of protecting investors from fraud, Royer and Elgindy used the F.B.I.'s crime-fighting tools and resources actually to defraud the public, and to insulate themselves from detection and prosecution," Roslynn R. Mauskopf, the United States attorney in Brooklyn, said in a statement.

When the first guilty verdict was read, Mr. Elgindy, 36, placed his head in his hand and rocked back and forth, sobbing and moaning. Judge Raymond J. Dearie then stopped the proceedings so that Mr. Elgindy could be excused from the courtroom.

Mr. Royer, 41, who showed little emotion on the witness stand when he, unlike Mr. Elgindy, testified in his own defense, remained stoic after the verdict. "I honestly don't get it," he said outside the courtroom. He said he would appeal.

Mr. Royer was found guilty of racketeering and securities fraud charges. He was also convicted on obstruction of justice. Prosecutors said that Mr. Royer alerted Mr. Elgindy that the Justice Department was investigating him in relation to the Sept. 11 attacks.

Continued in article


ACE agreed to pay Marsh secret kickbacks to get an $80 million state contract, Connecticut's attorney general said in a suit.

"Lawsuit Alleges ACE Paid 'Kickbacks' to Marsh," by Ian McDonald and Theo Francis, The Wall Street Journal, January 24, 2005, Page C3 --- http://online.wsj.com/article/0,,SB110633876506832814,00.html?mod=home_whats_news_us 

Property-casualty insurer ACE Ltd. agreed to pay Marsh & McLennan Cos. secret "kickbacks" to secure an $80 million state contract, Connecticut Attorney General Richard Blumenthal alleged Friday in a civil lawsuit that makes ACE the first insurer to face charges in the widening probes of insurance-broker compensation.

Mr. Blumenthal said Marsh, the world's biggest insurance broker, solicited a secret $50,000 payment from ACE in lining up the Bermuda insurer to take financial responsibility for certain of the state's workers' compensation claims. Mr. Blumenthal, whose lawsuit against the two companies seeks unspecified actual and punitive damages for the alleged unfair trade practices, says his office will file several more suits involving insurance brokers and insurers in coming weeks.

"Our investigation is expanding and broadening and we're increasingly disturbed by what we find," he said. "The more rocks we turn over, the more problems there seem to be." Spokesmen for ACE and Marsh said the companies continue to cooperate with authorities.

Mr. Blumenthal's allegations against Marsh and ACE echo many made in October by New York Attorney General Eliot Spitzer in a civil lawsuit filed against Marsh. That suit implicated but didn't charge several large insurers, including ACE. Since then, insurance-industry and legal specialists have predicted that Marsh and other firms would face a battery of charges from states' regulators.

Mr. Blumenthal's suit, filed in Connecticut Superior Court in Hartford, says that the state in 2001 paid Marsh $100,000 to act as a middleman in arranging an insurer to assume responsibility for 678 of the state's workers' compensation claims. Marsh agreed with the state that it wouldn't accept additional commissions, according to the suit. But internal Marsh documents indicate that Marsh solicited the $50,000 payment from ACE, according to the suit. The two firms agreed in writing not to disclose the payment, the suit alleges.

In the New York lawsuit, Mr. Spitzer alleged that Marsh cheated clients by arranging false bids for client contracts and steering business to insurers who paid Marsh so-called contingent commissions. Mr. Spitzer likened these commissions, which added up to $845 million of Marsh's $11.6 billion revenue in 2003, to kickbacks.

Marsh's board of directors met late last week to discuss terms of a potential settlement with Mr. Spitzer. People familiar with the talks have said the pact would cost $600 million to $750 million. It would codify certain business reforms and potentially include a statement of contrition, the people said.

Mr. Blumenthal's lawsuit shows that even a quick settlement with Mr. Spitzer won't necessarily end the company's troubles. Marsh has said it has received inquiries from more than two dozen state regulators; there is no sign yet that they will consolidate their efforts.

Mr. Blumenthal, who has sent subpoenas to 29 insurers and 15 brokers, noted that his office is examining similar practices in multiple lines of insurance, including health-care coverage. "Big brokers seem to be demanding additional payments from insurers, which are then concealed," he said. "The net impact is that costs are inflated and customers are deceived."

Continued in article

Bob Jensen threads on insurance scandals are at http://www.trinity.edu/rjensen/fraudRotten.htm#MutualFunds 


"Citigroup Warns of S.E.C. Action," Reuters, The New York Times, January 22, 2005 --- http://www.nytimes.com/2005/01/22/business/22sec.html?oref=login 

The S.E.C. may take action against Citigroup Asset Management; Citicorp Trust Bank; Thomas W. Jones, the former chief executive of the asset management unit; and three other people, one of whom is still with the unit.

Citigroup said the commission took issue with actions related to its creation and operation of an internal transfer agent unit serving more than 20 closed-end funds that the company managed

Continued in article

Bob Jensen threads on mutual fund scandals are at http://www.trinity.edu/rjensen/fraudRotten.htm#MutualFunds 


"'Safer' Mutual Funds Look Sorry," Ian McDonald, The Wall Street Journal, January 28, 2005 --- http://online.wsj.com/article/0,,SB110686375437638485,00.html?mod=todays_us_money_and_investing 

Money is leaking out of what are known as principal-protected mutual funds, as investors learn the perils of playing it safe. These funds' cautious investment style and steep fees have left their returns lagging far behind stock funds.

Continued in the article

Bob Jensen threads on mutual fund scandals are at http://www.trinity.edu/rjensen/fraudRotten.htm#MutualFunds 


January 21, 2005 message from David Albrecht [albrecht@PROFALBRECHT.COM

KPMG Hires Federal Judge

Firm Facing Investigation, Civil Charges

By Carrie Johnson and Brooke A. Masters Washington Post Staff Writers Friday, January 21, 2005; Page E01

Accounting giant KPMG LLP yesterday said it would hire U.S. District Judge Sven Erik Holmes to oversee its legal affairs, as the firm and the entire audit industry undergo unparalleled scrutiny from securities regulators and plaintiff lawyers.

Holmes, 53, chief judge of the U.S. District Court for the Northern District of Oklahoma, will resign his judicial post and join New York-based KPMG in March after its 1,600 partners formally approve his appointment to the newly created position of vice chair for legal affairs, the firm said in a statement.

"KPMG is strengthening its legal function to ensure that our structure, policies, and processes continue to meet the highest levels of quality and integrity as the rapid pace of change confronting the ...

continued in article at: http://www.washingtonpost.com/wp-dyn/articles/A25105-2005Jan20.html?referrer=email 

PWC, KPMG and EY are all in trouble. Deloitte probably isn't too far behind. What are we going to call the surviving firms after the Big Four succomb?

David Albrecht

Bob Jensen's threads on the legal woes of KPMG are at http://www.trinity.edu/rjensen/Fraud001.htm#KPMG 


A federal magistrate judge in Ohio has concluded that PricewaterhouseCoopers withheld evidence in an accounting fraud trial brought by an audit client.
"Judge Rules that PricewaterhouseCoopers Withheld Evidence," AccountingWeb, January 14, 2005 ---  http://www.accountingweb.com/item/100381 

A federal magistrate judge in Ohio has concluded that PricewaterhouseCoopers withheld evidence in an accounting fraud trial brought by an audit client. According to The New York Times, United States Magistrate Judge Patricia A. Hemann recommended a default judgment against the accounting firm for failing to turn over evidence sought by Telxon Corporation, which makes bar code readers. Hemann's report, completed in July, was unsealed Thursday and provided to The New York Times by a lawyer in the case.

The newspaper reported that the firm found multiple versions of documents in different places very late in the proceedings. "In some cases, it is difficult to avoid the conclusion" that PricewaterhouseCoopers "engaged in deliberate fraud," Hemann wrote. She also wrote that "there is strong evidence that documents have been destroyed, placing plaintiffs and Telxon in a situation which cannot be remedied."

The judge's recommendation goes to U.S. District Court Judge Kathleen O'Malley, who will order that the lawsuit proceed to consider damages if she adopts the magistrate judge's report, according to Jeffrey Zwerling, who represents shareholders. “Our experts tell us we have damages for that period of $139 million,” he said.

According to court papers, both sides battled for months over whether PricewaterhouseCoopers was required to produce certain papers related to its audit work at Telxon. The magistrate judge's report stemmed from motions filed by both Telxon and shareholders that the accounting firm should be sanctioned for failing to follow discovery rules.

"PricewaterhouseCoopers respectfully disagrees with the magistrate judge's report and recommendation,” the firm said in a statement. “We have filed extensive objections with the district court judge to the magistrate judge's recommendation. We acknowledge an error in discovering and producing documents in the litigation later than that should have occurred. At the same time we believe that our objections to the magistrate judge's recommendation are well founded."

Even if the district court judge rejects the magistrate judge's findings, they may hurt the firm's reputation, said Arthur W. Bowman, editor of Bowman First Alert, an accounting industry newsletter. "What the big four, the final four, use for differentiation now is, they are higher quality than the competition," Bowman said. "PricewaterhouseCoopers is one of those using that kind of strategy, and this kind of occurrence will destroy that."

Shareholders filed suit against Telxon after a restatement of earnings in 1998. The company settled the shareholder lawsuit last year, then filed a lawsuit against PricewaterhouseCoopers on the claim that the firm did not follow generally accepted accounting principles when it conducted its audits. Shareholders filed a separate lawsuit contending the firm approved improper financial statements.

Bob Jensen's threads on the legal woes of PwC are at http://www.trinity.edu/rjensen/Fraud001.htm#PwC 


From The Wall Street Journal Accounting Weekly Review on January 21, 2005

TITLE: College Loans: The Lost Concept of Repayment 
REPORTER: Letter to the Editor by Marie A. Bennett 
DATE: Jan 18, 2005 
PAGE: A17 
LINK: http://online.wsj.com/article/0,,SB110601364308628517,00.html  
TOPICS: Accounting, Bad Debts, Bankruptcy

SUMMARY: This opinion piece responds to a front page article from January 6, 2005, describing student loan collection techniques authorized by law. That article also including three case stories of individuals having difficulty repaying their loans. Students must read the related article to respond to questions.

QUESTIONS: 
1.) From whom may students obtain college loans? List all sources.

2.) When loans are obtained from commercial banks and students default on them, why does the government end up collecting on them? What is the purpose for this arrangement?

3.) What student loan collection techniques differ from those undertaken by commercial lenders? What techniques are similar?

4.) Consider the arguments presented in the opinion page letter to the editor from Marie A. Bennett, Higher Education Consultant, in contrast to the related article. What factors should you consider in deciding on the level of debt to undertake in order to finance your college education?

Reviewed By: Judy Beckman, University of Rhode Island

"College Loans: The Lost Concept of Repayment," The Wall Street Journal,  January 18, 2005; Page A17 --- http://online.wsj.com/article/0,,SB110601364308628517,00.html 

I read with great interest the Jan. 6 page-one article "College Try: U.S. Gets Tough on Failure to Repay Student Loans," wherein three stories were told of individuals who had defaulted on college student loans guaranteed by the federal government. In each case there was a version of the song, "If I had only known." Known what? That I wouldn't make much money as a cello player? That if I didn't complete my degree I wouldn't make much money? One defaulter said he wouldn't have gone to such an expensive school.

I may sound unsympathetic to their circumstances, but I assure you that I am not. But I am distressed by the failure of our schools and families to educate potential and current college students about the economics of the choices they make. In fact, we don't provide the vital consumer finance education to our youth that is critical to their economic success as adults. Where and when are they taught the true costs of borrowing and the true costs and benefits of education? Where and when are they taught how to assess the cost of education relative to the career and income potential?

Almost 40 years ago I was the only freshman in my college dormitory who knew how to balance a checkbook and to throw away the credit card offers until graduation. Thirty-five years later I was stunned to learn that my daughter was the only one in her dormitory with the same knowledge.

Marie A. Bennett
Higher Education Consultant
Rockville, Md.

When someone is the beneficiary of the public's largesse, there is a responsibility to act in kind -- responsibly. To provide accessible, low-interest loans is a gift in and of itself. Without repayment, these wouldn't be loans but outright gifts, and they wouldn't have been made initially. Gifts come from family members; let them ask family members.

Roger Weir
Chicago

--- RELATED ARTICLES --- 
TITLE: U.S. Gets Tough On Failure To Repay Student Loans 
REPORTER: John Hechinger 
PAGE: A1 
ISSUE: Jan 06, 2005 
LINK: http://online.wsj.com/article/0,,SB110497406688418357,00.html 


Not so much fidelity at Fidelity

"2 more leave Fidelity amid probe Traders depart as SEC examines gifts by brokers," by Andrew Caffrey, The Boston Globe, January 21, 2005 --- http://www.boston.com/business/articles/2005/01/21/2_more_leave_fidelity_amid_probe/ 

Fidelity spokeswoman Anne Crowley also declined to say whether the company has taken additional disciplinary action beyond those it disclosed last month, when it fined or sanctioned 14 traders and said two others left after its own internal inquiry revealed violations of its gifts policies.

Among the employees Fidelity has fined is the prominent head of its stock-trading operation, Scott DeSano, according to attorneys involved in the case and news accounts. DeSano remains in his position.

Fidelity is the subject of a wide-ranging probe by securities regulators, one that has subpoenaed scores of brokers and traders in Boston's financial community. According to lawyers and others involved in the case, investigators are trying to determine if the gift-giving, which included fancy dinners, expensive wines, and trips to out-of-state golf courses and sporting matches, were the partying antics of a close, macho trader culture, or whether the Fidelity traders had in effect, a "pay to play" system, in which brokers who wanted a piece of the fund company's prodigious trading volume had to pony up presents.

Continued in article

Bob Jensen's threads on mutual fund scandals are at http://www.trinity.edu/rjensen/fraudRotten.htm#MutualFunds 


"Fidelity's antitiming fees anger big clients," by Andrew Caffrey, The Boston Globe, January 20, 2005 --- http://www.boston.com/business/articles/2005/01/20/fidelitys_antitiming_fees_anger_big_clients/ 

More than 130 of Fidelity's 350 funds have redemption fees. The costs vary from 0.25 percent to 2 percent per transaction. The new rules impose the fees when an investors buy into, and then sells out of, a fund within a certain time period, which can range from 30 to 90 days. The Fidelity policy comes as the Securities and Exchange Commission debates imposing a short-term trading fee rule throughout the industry.

The SEC proposal, and Fidelity's policies, are intended to curb the kind of rapid trading in and out of mutual funds that scandalized the industry in 2003 and 2004. Savvy traders such as hedge funds targeted international funds and other mutual funds that had extreme volatility or inefficiency in the pricing of the funds' holdings. In some cases, traders used retirement funds for these strategies because some did not have policies restricting frequent trades.

Such frequent exchanges drives up a fund's trading expenses -- costs that Fidelity said are paid for by other long-term shareholders in the fund. Fidelity said it is only fair that those other shareholders be reimbursed by investors whose short-term trading drives up a fund's costs.

Continued in article

Bob Jensen's threads on mutual fund scandals are at http://www.trinity.edu/rjensen/fraudRotten.htm#MutualFunds 


"'Fair Disclosure' Inhibits Speech, U.S. Chamber of Commerce Says," by Phyllis Plitch, The Wall Street Journal, January 20, 2005, Page C3 --- http://online.wsj.com/article/0,,SB110617311498830579,00.html?mod=todays_us_money_and_investing 

In its latest effort to limit the Securities and Exchange Commission's power, one of the nation's top business groups has slammed the agency's so-called fair-disclosure rule as a constitutionally suspect, congressionally unsanctioned intrusion into corporate affairs.

Diving into the first challenge of the SEC's four-year-old Regulation FD, the U.S. Chamber of Commerce has filed court papers in support of Siebel Systems Inc.'s attempt to dismiss an SEC action against the company.

"In punishing companies for selectively disclosing 'material and nonpublic' information, Regulation FD impairs fundamental First Amendment values," the chamber wrote in its friend-of-the-court brief. "It either compels corporate executives to engage in unwanted discourse with the public at large, thereby inhibiting their right to freedom of speech and association, or causes them to restrict their speech altogether to avoid violation of the regulation."

In seeking to weigh in on the Siebel case, the chamber is once again showing its willingness to come between the nation's top securities regulator and the U.S. companies and investment firms under its watch. The organization is also challenging the SEC's authority to pass new standards forcing 75% of mutual-fund directors to be independent.

In many respects, the chamber's arguments parallel those made by Siebel in its own court papers. In its motion to dismiss the SEC's complaint, the San Mateo, Calif., business-software company also argued that the agency lacked statutory authority to pass the regulation and that the regulation violates the First Amendment.

Continued in the article

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


"To Err Is Human, to Restate Financials, Divine," by Diya Gullapalli, The Wall Street Journal, January 20, 2005, Page C3 --- http://online.wsj.com/article/0,,SB110616621316030440,00.html?mod=todays_us_money_and_investing 

Companies had to restate financial reports in record numbers in 2004. But that wasn't necessarily a bad thing.

Error-driven restatements were up 28% to 414 last year, according to data to be released today by Huron Consulting Group LLC, a financial advisory firm. But investors shouldn't necessarily be alarmed by the big increase because, the report's authors say, the jump may partly reflect that more errors are being caught now than in years past, not that more are occurring.

One big reason more would be caught are the requirements of the 2002 Sarbanes-Oxley corporate-governance act, under which a company's outside auditor and its top brass must annually certify the soundness of internal financial-reporting controls. The certification procedure kicked in for the first time at many companies this past November.

The intense focus on public companies to "thoroughly document, test and take responsibility for the effectiveness of their company's safeguards for quality financial reporting has resulted in an unprecedented period of scrutiny," says Joseph J. Floyd, a managing director of Huron and author of the report.

The Huron study covers error-driven restatements involving either an annual report or quarterly financial statement. The previous record for such restatements was in 2002, when a then-record 330 restatements occurred. In 2003, the number leveled off to 323 restatements.

Errors involving improper booking of revenue were behind 16.4% of the restatements last year, followed closely by mistakes involving accounting for stock options, other stock instruments and earnings per share. Another source of errors was accounting for reserves for accounts receivable, inventory, restructuring and other loss contingencies.

Beefed up regulation also drove last year's surfeit of restatements. During its inspections of audit firms earlier last year, the new Public Company Accounting Oversight Board found problems with debt classification on one of the balance sheets it was examining, and that discovery prompted the regulators to cast a broader net. Ultimately, about 25 companies restated their financial reports as a result. Also, the Securities and Exchange Commission changed its reporting requirements to make error-driven restatements easier to spot.

The crop of companies in 2004 that completed restatements include Cardinal Health Inc., El Paso Corp. and SunTrust Banks Inc. Of companies restating results last year, about 15% were "repeat filers," which Huron defines as companies that have reported erroneous financial information on more than one occasion since 1997. In this category: Tyco International Ltd.

Manufacturing companies filed about one-third of the restatements last year, with finance, insurance and real-estate companies accounting for 17% of redos. Companies in a range of other industries, including transportation, communications and sanitary services, comprised 13% of restatements; and software companies made up 12%.

While companies with more than $1 billion in revenue accounted for 19% of restatements in both 2003 and 2004, the number of small companies that restated declined last year. Companies with less than $100 million of revenue comprised 39% of restatements last year, down from 49% in 2003.

Huron also noted a continued rise in the number of companies restating more than one year of financials in a single filing. For the fifth consecutive year, the number of filers reporting errors in at least three prior annual periods rose to nearly 40% of the annual reports restated. For example, Bally Total Fitness Holding Corp. announced that it would restate eight years of financial reports, from 1996 to 2003, to record a liability for certain membership contracts sold by a subsidiary before Bally acquired it.

Expect more high-profile restatements in the months ahead. For example, Fannie Mae and Krispy Kreme Doughnuts Inc. recently announced that they would restate financial results for certain years past.

Restatements are often an embarrassment to the auditing firms.  Problems in the auditing firms are highlighted at http://www.trinity.edu/rjensen/Fraud001.htm#others 

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

 


I've always viewed stock dividends as a sham that makes shareholders think they're getting something good when in an accounting sense they're only getting screwed.  I never could convince my dad that when Sun Oil cut his cash dividend and sent him more shares of stock that he was being had in two ways.  Be that as it may, stock dividends are becoming more popular once again.

"Tax Cut, Shareholder Pressure Stoke Surge in Stock Dividends," by Jeff D. Opdyke, The Wall Street Journal, January 18, 2005, Page A1 --- http://online.wsj.com/article/0,,SB110599926403228151,00.html?mod=home_whats_news_us 

Out of favor for years, stock dividends have surged back. U.S. companies last year paid out a record $181 billion in dividends -- which doesn't even include Microsoft Corp.'s one-time payout of $32.6 billion in December. And 2005 looks to be even better.

Behind the trend is pressure from shareholders, who aren't content with the stock market's flat performance in recent months and who are looking to dividends as a sign of healthy, real profits. In addition, the 2003 dividend-tax cut has prompted companies to pay out an increasing share of their profits rather than stash the cash or reinvest it. Some companies, notably Microsoft, have started paying dividends for the first time.

Investors are rushing into the initial public offerings of companies that promise not rapid growth but chunky dividends. They're increasingly pouring money into equity-income mutual funds, which focus largely on owning stocks of dividend-paying companies. All this activity also is helping to close the gap with overseas companies, which in recent years have paid higher dividends generally than U.S. companies.

Standard & Poor's estimates that 2005 will be another blockbuster year, with dividends on an annual basis increasing at least 12% from last year's level. Insurance giant American International Group Inc. this month announced that, effective with its March 18 dividend payment, it will raise the quarterly payout by 67%, to 12.5 cents a share from the 7.5 cents it paid previously.

Continued in the article


"WorldCom's Audacious Failure and Its Toll on an Industry," by Ken Belson, The New York Times, January 18, 2005 --- http://www.nytimes.com/2005/01/18/business/18ebbers.html?oref=login  

Regardless of the case's outcome, Mr. Ebbers's business demise continues to reverberate well beyond the courtroom. WorldCom - doing business again as MCI, the company's original name - is half its former size and struggling to survive. And whether or not one believes that he masterminded an accounting fraud, there is little doubt that the telecommunications industry, whose 1990's boom Mr. Ebbers help fuel with his deal making, is in a shambles - riddled with heavy debt, sagging stock prices and network overcapacity.

Phone carriers, emerging from the financial ruins, are relying less on the long-distance and data services that Mr. Ebbers championed, and more on bundles of products like wireless and video that can attract customers with deeper pockets.

More broadly, corporate America is coming to terms with life after WorldCom. The company's downfall led Congress to answer critics' calls for action by reviving stalled legislation that became the Sarbanes-Oxley Act of 2002, a sweeping piece of corporate reform legislation. Companies of all sorts are spending millions of dollars to comply with the law, which has increased accountability but, critics say, also stifles innovation.

Continued in article


Steve Albrecht (former American Accounting Association President and Professor of Accounting at Brigham Young University) conducted interviews when Barry Minkow was still in prison.  You can read Steve's account of the ZZZZ Best Fraud at http://www.swcollege.com/vircomm/stice_survey/sts/sts04.html 

Question
Why is there so much investment fraud?

Answer
What we have is a perfect fraud storm. In places across the country with an appreciating housing market, low interest rates, and consumers dissatisfied with Wall Street returns, you'll find people ripe for [perpetrators].
"Ten Questions for Barry Minkow," CFO Staff, by CFO Magazine, January 2005, Page 20 --- http://www.cfo.com/article.cfm/3516399/c_3516777?f=magazine_alsoinside 

The current head of the Fraud Discovery Institute, Barry Minkow, also served more than seven years in prison for the infamous ZZZZ Best scam.

Barry Minkow says he plans to be remembered for more than the ZZZZ Best Co. fraud. The 38-year-old Minkow served more than seven years in prison for the infamous 1980s scam. But he hopes that his current efforts as head of the Fraud Discovery Institute and as pastor of The Community Bible Church in San Diego will supersede his activities as CEO of the carpet-cleaning company. This month his new book, Cleaning Up (Nelson Current), debuts.

1. Currently, you are fighting the very crime you were convicted of. Isn't that ironic?
No one failed worse than I did at such a young age. Sure, you can adjust the dollar amounts and say it was $10 billion with Bernie Ebbers at WorldCom, but it doesn't matter. I was CEO of a public company and I failed. [ZZZZ Best] was a fully reporting public company with a stock that went from $12 to $80. And at 21, I got a 25-year sentence and a $26 million restitution order, and that's [since been] turned into $1 billion in fraud uncoverings.

2. What can other white-collar criminals glean from your mistakes?
Jeff Skilling's and Andy Fastow's best days are ahead of them...if they admit they did wrong, do whatever they can to pay back their victims, and use the same talents they used to defraud people to help them.

3. When you speak to executives about fraud, what's your main message?
When I speak to executives, I wear my orange prison jumpsuit. It's gimmicky... [but] the best way to stop fraud is to talk people out of perpetrating it in the first place by doing two things: increasing the perception of detection and increasing the perception of prosecution.

4. Are you surprised that the fraud techniques you used are still out there?
It doesn't surprise me at all. Long before Enron was touring people on phony trading floors, ZZZZ Best was touring people on buildings for restoration jobs that we never did. Now the variation on a theme is always there, but here's what we do: we lie about what we owe and we lie about what we earn.

5. On what do you blame the rash of corporate fraud in recent years?
It's a mentality called right equals forward motion and wrong is anyone who gets in my way. You see, we used to endorse character and integrity, but today the business ethic that reigns is achievement. And whenever you establish the worth of someone based on what they can do and not on who they are, you have created the environment for fraud.

6. Are you skeptical of efforts, such as Sarbanes-Oxley, to legislate ethics?
Let me tell you why this legislation is brilliant. Sarbox hit at a common denominator of corporate fraud: bypassing systems of internal controls. I would not have been able to perpetrate the ZZZZ Best fraud if I had not been able to bypass the system of internal controls. And you know who are heroes now — the internal auditors and the Public Company Accounting Oversight Board. Unless you're a perpetrator, you don't know how good these moves are.

7. Should the sentencing guidelines for white-collar criminals be overhauled?
Yes, and judges should have more discretion. My judge is the one who said that I had no conscience. Two years ago, he dismissed my $26 million restitution order, dismissed me from probation three years early, and told me to go out and fight corporate fraud. [But] I don't care if anyone goes to jail. The number-one thing white-collar criminals need to do is give the money back to those hurt the most.

8. When will you be satisfied that you've repaid your debt to society?
I won't be. Union Bank had a $7 million loan [against ZZZZ Best], and I have a long way to go. But I haven't missed a payment in nine years. They've gotten over $100,000 this year alone.

9. Why is there so much investment fraud?
What we have is a perfect fraud storm. In places across the country with an appreciating housing market, low interest rates, and consumers dissatisfied with Wall Street returns, you'll find people ripe for [perpetrators].

10. What do you say to those who doubt your conversion to the straight and narrow?
There's this great phrase in the Bible: "When the man's ways please the Lord, he makes even his enemies be at peace with him." The biggest critics of Barry Minkow should be law enforcement. They absolutely know if someone is a fake or real. But they've been my biggest supporters.

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

In particular note the quotations at http://www.trinity.edu/rjensen/fraud001.htm#Quotations 


"9 Executives Face Charges of Sales Fraud," by Constance L. Hays, The New York Times, January 14, 2004 --- http://www.nytimes.com/2005/01/14/business/14ahold.html  

Nine current and former sales executives from an assortment of food companies were charged yesterday with participating in a scheme that created a huge accounting fraud at U.S. Foodservice, which has been under investigation in the United States and in the Netherlands for the last two years

The executives were arraigned in Federal District Court in Manhattan on conspiracy charges and released. They worked for companies that sold products like sugar, eggs, seafood and cake mix to U.S. Foodservice, which in turn supplied restaurants, corporate dining rooms and other institutions.

All the executives are accused of approving documents that claimed U.S. Foodservice, a unit of Royal Ahold, was owed millions of dollars more in promotional allowances - a type of rebate offered by manufacturers to stores and distributors - than was actually the case.

The scheme had the effect of inflating U.S. Foodservice's profits, prosecutors say.

This is part of the previously reported fraud at Ahold.

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 

Ahold was an Deloitte & Touche auditing client.  You can read more about this and other troubles at Ernst & Young by going to 


A Topic for Class Debate

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

 

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

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

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


Executives on Trial

"The Latest Developments," The Wall Street Journal, January 14, 2004 --- http://online.wsj.com/documents/info-trials05.html 

 
BERNARD J. EBBERS
Former chairman and chief executive of WorldCom
 
L. DENNIS KOZLOWSKI
Former Tyco International chief executive officer
 
KENNETH LAY
Former Enron chairman and CEO
 
RICHARD M. SCRUSHY
Former HealthSouth Corp. chairman and CEO
THE CASE WorldCom went from being one of the biggest stock-market stars of the past decade to being the biggest case of accounting fraud in U.S. history after falsifying earnings reports to show continued profits. Investigators say Mr. Kozlowski, with former finance chief Mark Swartz, looted about $600 million from Tyco in unauthorized compensation and illicit stock sales, using questionable accounting practices to hide the misdeeds. Prosecutors and regulators say the former energy giant created off-the-books partnerships and used aggressive accounting methods to hide massive debt and inflate the firm's bottom line. Mr. Scrushy is accused of orchestrating a massive fraud that inflated the health-care company's earnings to meet Wall Street expectations.
UNCOVERED In early 2002, the SEC launched inquiries on the heels of a sharp cut in earnings forecasts from the company. WorldCom disclosed the accounting fraud on June 25, 2002. Mr. Ebbers was indicted in March 2004. Mr. Kozlowski was indicted in the Tyco case in September 2002. His first trial began in October 2003 and ended in April 2004. (Separate charges of tax evasion were handed down in June 2002.) The SEC launched an investigation in October 2001 after Enron booked a hefty charge related to sour investments (among them, a pair of limited partnerships run by the company's CFO). The company sought court protection from creditors in December 2001. In September 2002, the SEC requested a range of company documents for a fact-finding accounting inquiry. In March 2003, federal agents raided HealthSouth's headquarters and the SEC filed a civil case against HealthSouth and Mr. Scrushy.
IMPACT The collapse wiped out shares with a market capitalization of $115 billion at their peak in 1999. The fraud itself amounted to about $10.6 billion from moves that boosted earnings by understating expenses. The company admitted to overstating income from 1998 to 2001 by $1.15 billion. The tipping-point charge to earnings totaled $1.01 billion; CFO Andrew Fastow made an estimated $45 million from his partnerships' dealings with Enron. Earnings were inflated to the tune of $2.5 billion.
MAIN
CHARGES
Securities fraud, conspiracy and causing the company to make false filings with securities regulators. Mr. Kozlowski faced 24 counts, including several counts of grand larceny, securities fraud and falsifying business records, in his first trial. Earlier, the judge dismissed several other counts, including an enterprise corruption charge. Mr. Lay faces 11 criminal counts of securities fraud and wire fraud, in addition to charges of fraud and insider trading from the SEC. 58 federal criminal charges, including the first of providing false certifications to securities regulators under the Sarbanes-Oxley Act; conspiracy; making false statements and money laundering.
DEFENDANT'S
STATUS
Awaiting trial, with jury selection scheduled to start Jan. 18 and opening statements around Jan. 24. Awaiting retrial after the first trial, which came to symbolize the worst of corporate greed and excess, was declared a mistrial in April 2004. Jury selection begins Jan. 18, with testimony expected in February. He has been indicted; trial's timing and location to be determined this month. In November 2003, Mr. Scrushy pleaded not guilty to a list of 85 charges that later were consolidated into the 58 on which he is awaiting trial. Opening arguments are to begin on Jan. 25.
OTHER MAJOR
DEFENDANTS
Scott Sullivan
Former CFO
Pleaded guilty in March 2004 to orchestrating the fraud and is expected to testify against Mr. Ebbers

Jack Grubman
Former Salomon Smith Barney telecom analyst, one of WorldCom's most bullish supporters
Agreed to pay $15 million and be barred from the securities industry for life
Mark Swartz
Former CFO
Also awaiting a retrial

Mark Belnick
Former general counsel
Acquitted of grand larceny, securities fraud and falsifying business records
Andrew Fastow
Former finance chief
Pleaded guilty to fraud and admitted to conspiracy to inflate profits in return for a 10-year sentence

Jeffrey Skilling
Former CEO
Pleaded not guilty to 42 counts, from conpiracy to securities fraud; awaits trial; Mr. Fastow is expected to testify against him.
More than a dozen former HealthSouth executives have pleaded guilty in the case, including five former chief financial officers.
COMPANY'S
STATUS
In July 2002, WorldCom filed for Chapter 11 bankruptcy-law protection. It emerged last April and was renamed MCI. Tyco is under new management and thanks to a restructuring program has posted strong advances in profit for recent quarters. After three years under court protection, what remained of Enron was broken up into independent companies (CrossCountry Energy, Portland General Electric and Prisma Energy International) and sold in autumn 2004. HealthSouth, with a new raft of executives, recently settled an unrelated lawsuit over Medicare fraud dating back to the 1990s and has announced expansion plans.
FOR MORE
INFORMATION
Trial of WorldCom's Ebbers Will Focus on Uneasy Partnership
1/12/05
Lifting the Curtain: Tyco Retrial to Get Started
1/14/05
For Enron's Ex-Chief, Spotlight Shines on His Public Statements
1/5/05
Scrushy Indicted on Fraud Charges
11/5/03

You can read about these and America's history of other corporate criminals at http://www.trinity.edu/rjensen/415wp/AmericanHistoryOfFraud.htm 


Question
If you bought mutual funds from a stock broker working for Edward E. Jones, Inc., what nasty secret was probably not revealed to you by your broker?

 

Answer
Edward D. Jones disclosed that it received $82.4 million in secret payments from seven funds as incentives to sell their products.
'Jones Discloses Secret Payments From Fund Firms," by Laura Johannes and John Hechinger, The Wall Street Journal, January 14, 2004, Page C1 --- http://online.wsj.com/article/0,,SB110565044387025581,00.html?mod=todays_us_money_and_investing 

Edward D. Jones & Co. received $82.4 million in secret payments from seven mutual-fund firms in the first 11 months of 2004, through a lopsided fee structure that in some cases gave the brokerage firm more compensation for selling poorly performing funds than for selling stellar performers.

The disclosures were posted yesterday, on Jones's Web site as required by its $75 million agreement to settle regulatory charges that it failed to adequately disclose the payments to investors. They are by far the most detailed figures ever made public on the industry practice of mutual-fund companies paying brokerage firms to induce them to sell their products, an arrangement known as revenue sharing. Unlike front-end sales commissions, which are widely disclosed to consumers, revenue sharing has been largely secret.

Revenue sharing is legal, but federal and state regulators have argued that the industry's failure to disclose the payments defrauds consumers by hiding brokers' conflicts of interest. Federal regulators allege that the large payments that Edward D. Jones got from its seven preferred mutual-fund families would cause brokers to pick those funds over other fund companies that aren't paying the firm. Other brokerage firms have begun to make disclosures about these payments in the face of increased regulatory scrutiny.

Edward D. Jones, of St. Louis, has nearly 10,000 sales offices nationally, making it the largest network of brokerage outlets in the U.S. Its revenue-sharing practices were the subject of a page-one article in The Wall Street Journal in January 2004. Jones's spokesman John Boul declined to comment for this article, although Jones and other brokers long have argued that preferred lists help them narrow choices among the thousands of U.S. mutual funds.

According to Jones's disclosures, the brokerage firm received two types of revenue-sharing payments. One was a one-time payment based on the dollar amount of a particular mutual-fund family's shares sold by Jones's brokers. The other: annual "asset fees" based on the total value of a fund family's assets held by Jones's clients.

You can read more about the Edward D. Jones and other brokerage and investment advising scandals at http://www.trinity.edu/rjensen/fraudRotten.htm 

 


Question
What is the hidden "g-fee" in your monthly mortgage payment and why doesn't it stand for the "good-fee?"

 

Answer

Most likely the company who initially financed your house sold that mortgage to big Fannie or her somewhat smaller brother Freddie who then tacked on a hidden g-fee that you’ve been paying every month.  Freddie and Fannie are quasi-private companies owned by shareholders.  Both companies can borrow at relatively low rates since the U.S. government co-signs their borrowings.  If these companies default upon their hundreds of billions in debt, it may well become a costly scandal analogous to the Savings & Loan scandal which most of you probably remember cost taxpayers billions of dollars.  Recently Fannie Mae’s CEO and CFO were forced out for accounting manipulations that were not allowed by accounting standards.  Fannie’s auditor, KPMG, was also fired.  This was the second time around for FAS 133 violations by Fannie Mae.  Freddie Mac also got caught up in a FAS 133 accounting scandal.


"Hidden Fees in Most Mortgages Bring Scrutiny to Fannie, Freddie," by John R. Wilke, The Wall Street Journal, January 14, 2004, Page A1 --- http://online.wsj.com/article/0,,SB110565253953225630,00.html?mod=home%5Fpage%5Fone%5Fus 

Fannie Mae and Freddie Mac have helped millions of Americans buy and refinance homes. Along the way, they've helped themselves to huge profits from little-known fees tucked into most monthly mortgage payments.

The most significant of these fees covers a guarantee that the loan will be paid by the homeowner on time each month. The fee, called a guarantee fee or a "g-fee," brought in an estimated $4 billion for the mortgage giants last year. But lenders have long complained that with no significant competition, Fannie and Freddie have kept the fees far above cost.

Now the fees, which can total thousands of dollars for consumers over the life of a mortgage, are emerging as a new battleground in the regulatory scramble to rein in the two mortgage giants after financial-reporting scandals ousted top officials at both companies.

In a previously undisclosed analysis provided last month to members of Congress, Fannie's and Freddie's primary regulator concluded the federally chartered companies use their market clout and government privileges to keep the fees high, yielding excessive profits at the expense of millions of homeowners. The fees, which Fannie and Freddie sometimes move in lockstep, may also raise antitrust issues, according to the analysis by the Office of Federal Housing Enterprise Oversight. Congress is considering new legislative curbs on the mortgage giants that could slow their growth and lead to tougher oversight.

Critics of Fannie and Freddie say g-fees should rise and fall with the companies' actual losses due to mortgage defaults. Instead, the fees in 2003 amounted to 33 times those losses -- a big jump from 4.4 times credit losses in 1995, according to internal figures cited by Ofheo. That means that despite falling losses due to defaults, guarantee-fee rates remain high. The banks say consumers should be paying hundreds of millions of dollars less in g-fees and other charges.

Sharon McHale, Freddie's spokeswoman, says Freddie's g-fees "are appropriate and competitive in today's market" and that investors "expect a reasonable rate of return or profit." Richard Syron, Freddie's chief executive, says that "it's very hard to make the argument that we are being rapacious."

The mortgage giants insist they face plenty of competition. "The secondary [mortgage] market is highly competitive, and lenders have numerous options available in the marketplace," says Charles Greener, Fannie's spokesman. Both companies are also under new management and have vowed to work to respond to their critics and work more closely with regulators.

Consumers have a big stake in the battle. On a typical $250,000 home loan, the g-fee is about $500 a year at the beginning of the loan's term and totals $11,350 over the loan's 30-year life. Fannie and Freddie impose many other charges, including fees for the use of proprietary technology the companies push bankers and brokers to use when their customers apply for a mortgage. Other transaction charges have become an increasingly important source of revenue, including a recently created fee on "cash out" refinancings made popular by falling interest rates in recent years.

Continued in the article

Fannie's Unethical Tone at the Top:  There's More Wrong Than Just Accounting Fraud
Fannie Mae, eager to unload a batch of fraudulent loans it purchased from a North Carolina lender, knowingly allowed the lender to resell the loans to a government mortgage agency, according to federal law-enforcement officials. A federal judge in Charlotte, N.C., has ordered Fannie Mae to forfeit $6.5 million for not informing the agency about the fraud.

Dawn Kopecki, "Fannie Is Ordered to Forfeit $6.5 Million," The Wall Street Journal, November 30, 2004 --- http://online.wsj.com/article/0,,SB110178387928686489,00.html?mod=home%5Fwhats%5Fnews%5Fus 

Bob Jensen's threads on the Fannie Mae and Freddie Mac accounting frauds can be found at http://www.trinity.edu/rjensen/caseans/000index.htm 


The infamous McKesson & Robbins (now known as McKesson)
Mckesson & Robbins scandal of 1938 is probably the best known auditing fraud in the 20th Century.. A crisis in public accounting was provided by the celebrated McKesson & Robbins case. McKesson & Robbins, Inc., whose financial statements had been audited by Price Waterhouse & Co., had inflated inventory and receivables by $19 million dollars through falsification of supporting documents.  The auditors merely accepted inventory and receivables balances reported by management without bothering to even verify their existence in McKesson & Robbins.  This fraud changed CPA auditing standards to require on-site test checking to verify the existence of warehouses and inventory.
Now McKesson is in the news again on the fraud beat.

McKesson, the nation's largest drug distributor, agreed to pay $960 million to settle a lawsuit based on accounting fraud at HBOC, a health care software company.

In indictments involving the case, prosecutors said HBOC sold software or services to more than a dozen hospitals with conditional "side letters" that allowed the hospitals to back out of the deals. The side letters were then hidden from auditors and the transactions were reported as sales.
"
McKesson Agrees to Pay $960 Million in Fraud Suit," by Milt Freudenheim, The New York Times, January 13, 2005 --- http://www.nytimes.com/2005/01/13/business/13settle.html 

McKesson, the nation's largest drug distributor, said yesterday that it had agreed to pay $960 million to settle a class-action lawsuit based on accounting fraud at HBOC, a health care software company that it bought in 1999.

The settlement, which will be divided among New York State pension funds and thousands of other plaintiffs, was one of the largest in history on a list led by $3.2 billion in a class-action suit against the Cendant Corporation and more than $2.6 billion in the WorldCom case, including payments by WorldCom directors.

The settlement ends a suit filed after McKesson shareholders lost $8.6 billion in one day, April 28, 1999, nearly half the value of their holdings. The stock plunged after McKesson said that HBOC had improperly booked sales and that it would restate earnings and revenues.

McKesson said it would take an af-ter-tax charge of $810 million, or $2.70 a share, in its Dec. 31 quarter and would set aside $240 million for remaining related lawsuits.

John H. Hammergren, who took over as chief executive in 1999 after McKesson's top officers were ousted, said yesterday in a telephone interview that the company had held back on spending in anticipation of the settlement. It reported $1 billion in cash on hand on Sept. 30.

"It's a relief to put this ordeal behind us," Mr. Hammergren said.

Eric W. Coldwell, a health care securities analyst with Robert W. Baird & Company in Chicago, said that "very little of the settlement is covered by insurance," but he said McKesson had reduced its debt and rearranged its finances and would not have to go to Wall Street seeking money to cover the settlement.

Continued in article

The external auditor is Deloitte and Touche.

Bob Jensen's threads on Deloitte's troubles are at http://www.trinity.edu/rjensen/fraud001.htm#Deloitte 


Question
What is "cookie jar" accounting?

Answer
Earnings management, often revenue reporting manipulation, that entails the use of reserves to smooth earnings volatility.

Canada-Based Nortel Accounting Cookie Jar Accounting Update:  
Details Mistakes, Says Executives Will Return Millions in Bonus Payments.  Five directors, including Chairman Lynton Wilson and former ambassador James Blanchard, who is also a former Michigan governor, will step down. 

"Nortel Unveils New Accounting Flubs," Mark Heinzl and Ken Brown, The Wall Street Journal, January 12, 2005, Page A3 --- http://online.wsj.com/article/0,,SB110544849421122680,00.html?mod=home%5Fwhats%5Fnews%5Fus 

Nortel Networks Corp. unveiled details of additional accounting errors involving billions of dollars and said that a dozen executives will return millions of dollars of bonuses as the telecom-equipment maker attempts to put a major financial scandal behind it.

The Brampton, Ontario, company also said five directors, including Chairman Lynton Wilson and former ambassador James Blanchard, who is also a former Michigan governor, will step down. Nortel's board has faced criticism for allowing the company's accounting fiasco to go on and approving the bonus plans, but none of the five directors was accused of wrongdoing in a company investigation, details of which were announced yesterday.

Nortel said 12 of the company's most senior executives will take the unusual step of returning $8.6 million in bonuses they were paid based on the erroneous accounting. Already, Nortel's accounting problems led to the ouster of 10 top executives last year.

It is very rare for senior executives to voluntarily refund bonuses following an earnings restatement, several pay specialists said. "This is something very, very new," said Robert Fields, an attorney and executive-compensation consultant in South Salem, N.Y. An increased emphasis on corporate governanceby boards "is really putting executives' feet to the fire," said Mr. Fields, adding that the voluntary return of executive bonuses "should see a lot more play in the future."

Nortel executives said the board also will seek repayment of bonuses paid to executives who have already been ousted. People familiar with the company say that there may be additional disciplinary actions taken against current employees.

Nortel's actions came as the company filed with regulators its financial statements for 2003 and restated, for the second time, its results from earlier years.

Nortel shares soared in the late 1990s and collapsed along with the technology bubble. But Nortel then made good on a promise by former Chief Executive Frank Dunn to return to profitability in early 2003.

Mr. Dunn and six other top executives were fired in April. He and his lawyer didn't return calls seeking comment.

But that early 2003 profit and the gains in subsequent quarters turned out to be illusory. Investigators hired by Nortel's directors determined the company improperly employed a financial maneuver, known as "cookie-jar accounting," that turned a loss into a profit. The profits triggered millions in bonuses for senior executives, but eventually unraveled. The board later brought in outside investigators, who uncovered details of the improper accounting.

Investors appeared relieved Nortel is getting a handle on its accounting scandal. Shares of Nortel rose 14 cents, or 4.2%, to $3.48 at 4 p.m. in New York Stock Exchange composite trading yesterday. Yesterday's filing detailed a different set of accounting issues beyond the cookie-jar accounting originally uncovered by investigators. The company said the newly reported errors resulted in higher revenues and profits for Nortel in 1999, 2000 and 2001.

In addition, Nortel said its 2003 financial statements show net income of $434 million, or 10 cents a share, on revenue of $10.2 billion. Before announcing its revisions, Nortel originally had reported net income of $732 million, or 17 cents, on revenue of $9.8 billion.

The latest findings were made by Nortel personnel. The company has hired Washington law firm Wilmer Cutler Pickering Hale & Dorr LLP, which also conducted an earlier investigation for the company's board, to investigate the revenue-recognition issues. The inquiry into the revenue-recognition issue is continuing to look into questions of potential misconduct among Nortel executives.

At Nortel, while some of the revenue-recognition problem appears to be due to ignorance, there are some situations, people with knowledge of the company say, where the intentions are questionable.

In one situation, people with knowledge of the company say, Nortel sold $200 million worth of equipment to Qwest Communications International Inc., the regional Bell company based in Denver, and booked the revenue right before the end of 2000, boosting that year's results. But Nortel booked the revenue too soon, the company later determined, because Qwest hadn't taken title to the equipment. In yesterday's restatement, Nortel shifted the revenue to 2001. A Qwest spokesman declined to comment.

At Nortel, investigators ultimately found about $3 billion in revenue had been booked improperly in 1998, 1999 and 2000. More than $2 billion was moved into later years, about $750 million was pushed forward beyond 2003 and about $250 million was wiped away completely.

The company has mentioned the revenue-recognition issues for several months, but this is the first time it has released details of them.

The board members stepping down are: Mr. Wilson, the chairman; Yves Fortier; Sherwood Smith; Guylaine Saucier; and Mr. Blanchard, a former U.S. ambassador to Canada.

 

"Nortel Delays Restatement Again," WebCPA, November 12, 2004 --- http://www.webcpa.com/article.cfm?articleid=8886 

Nortel Networks Corp. said that revenue reporting issues and remaining accounting matters will again delay the restatement of its financial results.

Initially, the company said that it would restate results for 2003 and report results for part of 2004 by the end of September. It then said that it would file those statements at the end of October, and then postponed again until mid-November. Now, Nortel said that is targeting completion within one to two months.

Nortel plans to release preliminary unaudited results for 2003 and the first and second quarters of 2004 "as soon as practicable." It plans to release limited preliminary results for the third quarter of 2004 by mid-December.

"In the course of the company's reviews over the last two weeks, we have found a level of revenue restatement which warrants that we undertake a deliberate, focused but bounded double-checking of several revenue areas," Nortel president and chief executive Bill Owens said Thursday. "We have taken this decision to postpone our filings as a prudent measure to take the steps needed to ensure that we have captured all necessary corrections and adjustments in our restated results."

Owens, a former director, was named president and CEO in April, after the firm fired three of its top executives, including its former chief executive, and said that it would restate results as far back as 2001.

Nortel, which is under investigation by U.S. and Canadian securities regulators in connection with its past restatements, is the subject of criminal probes in the United States and in Canada. In August, the company fired seven more of its finance executives and said that it would trim roughly 10 percent of its workforce by the end of the year in an effort to cut costs.

Nortel increased previous revenue adjustments, which it said would cut revenue by $600 million in 1999 and $2.5 billion in 2000. Of the amount in 2000, about $250 million will be permanently reversed, while the remainder will be deferred and recognized in later years. It also revised revenue adjustments that increased annual revenues by 8 percent in 2001, 4 percent in 2002 and 5 percent in 2003 (adjusted from a previously announced 7 percent, 1 percent and 3 percent, respectively). Nortel said that it will cut net earnings for 2003 by 35 percent, down from the 50 percent previously announced.

The company is discussing other accounting matters with the Securities and Exchange Commission, including its historical and continuing accounting treatment of revenues recognized on sales of certain optical products containing embedded software.

Nortel also said that its shares could be delisted from the New York Stock Exchange and Toronto Stock Exchange if it fails to file its 2003 annual reports with the SEC and the Ontario Securities Commission by Dec. 15.

Nortel did finally release its 2003 audited financial statements --- http://snipurl.com/Nortel2003 
Details of accounting problems can be found at http://snipurl.com/NortelReview 
But later it announced some more "flubs."
"Nortel Unveils New Accounting Flubs," Mark Heinzl and Ken Brown, The Wall Street Journal, January 12, 2005, Page A3 --- http://online.wsj.com/article/0,,SB110544849421122680,00.html?mod=home%5Fwhats%5Fnews%5Fus 

Nortel's external auditor is Deloitte and Touche --- http://www.nortelnetworks.com/corporate/investor/reports/index.html 

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

Bob Jensen's threads on troubles at Deloitte and Touche, including a $2 billion lawsuit over Deloitte's Forest Re Inc. audits, are at http://www.trinity.edu/rjensen/fraud001.htm#Deloitte

 


Sadly, one of my former professors and Dean of the Graduate School of Business Administration at Stanford University, Bob Jaedicke,  is one of those paying up (although I'm told that insurance companies will pay most of the $168 million).  Bob was both a former member of the Board of Directors and Chairman of Enron’s Audit Committee.

"Enron Directors Reach $168M Settlement," by Michael Liedtke,  FindLaw, January 7, 2004 --- http://news.corporate.findlaw.com/ap_stories/f/1310/1-7-2005/20050107180016_07.html 

Eighteen former directors of scandalized Enron Corp. have reached a $168 million settlement, including a $13 million payout out of some of their own pockets, with shareholders burned by the financial shenanigans that culminated in the company's stunning collapse.

The agreement announced late Friday requires 10 of the former Enron directors to contribute a combined $13 million from the profits that they reaped from selling company stock before Enron revealed it had been grossly exaggerating its sales and profits. The debacle foreshadowed a wave of accounting scandals that sparked an overhaul of the country's corporate governance practices.

The directors paying an unspecified amount of money are: Robert Belfer, Norman, Blake, Ronnie Chan, John Duncan, Joe Foy, Wendy Gramm, Robert Jaedicke, Charles LeMaistre, Rebecca Mark-Jubasche and Ken Harrison, according to attorneys involved in the case.

Other directors who aren't personally paying money but are nevertheless covered by the settlement are: Paulo Ferraz-Pererira, John Mendelsohn, Jerome Meyer, Frank Savage, John Urquhart, John Wakeham, Charls Walker and Herbert Winokur.

None of the directors are admitting any wrongdoing as part of the settlement, which still requires final court approval.

It represents the fourth major settlement negotiated by attorneys who filed a class action lawsuit on behalf of Enron's shareholders nearly three years ago. Including the latest settlement, the lawsuit so far has retrieved just under $500 million for shareholders in a debacle that helped spark a wave of new laws designed to improve corporate America's accounting practices.

Enron's financial meltdown wiped out tens of billions in shareholder wealth

Continued in the article

You can read more about how much the Directors and Officers made from Enron share sales at Enron's financial meltdown wiped out tens of billions in shareholder wealth at http://www.trinity.edu/rjensen/FraudEnron.htm#StockSales 

"Ex-Enron Directors Reach Settlement," by Rebecca Smith and Jonathan Weil, The Wall Street Journal, January 10, 2005, Page C3 --- http://online.wsj.com/article/0,,SB110514939934220521,00.html?mod=todays_us_money_and_investing 

Ten former Enron Corp. directors agreed to dig into their own pockets to pay $13 million of a $168 million settlement of litigation brought by shareholders whose investments were wiped out after the failed U.S. energy giant's 2001 bankruptcy filing.

Unveiled Friday, the settlement -- the burden of which falls largely on insurance companies -- follows one earlier in the week involving former WorldCom Inc. directors. Both accords resolve allegations that officials violated federal securities laws by permitting the release of public documents that contained material misstatements about company finances.

In Enron's case, 18 of 29 former directors named in a 2002 lawsuit agreed to settle civil claims against them, avoiding potentially larger judgments from a trial slated to begin in October 2006. On Wednesday, 10 former directors of telecommunications giant WorldCom agreed to pay $18 million of their own money as part of a total $54 million settlement.

Continued in the article

January 10, 2005 reply from Chuck Pier [texcap@HOTMAIL.COM

Bob Jaedicke was not the only educator on that list. Charles LeMaistre was the Chancellor of the University of Texas during most of the 1970's. However he wasn't from the Business side of education. If I remember correctly he was a physician.

Chuck

January 11, 2005 reply from Bob Jensen

Thanks Chuck,

You can read Dr. LeMaistre's sad testimony at http://www.senate.gov/~gov_affairs/050702lemaistre.htm 

 

January 10, 2005 reply from Roger Collins [rcollins@CARIBOO.BC.CA

I wonder - does anyone on this list remember the scandal surrounding the Allegheny Match Corporation? I seem to remember a report on that company by Business Week - and -if my memory serves me correctly - Bob Jaedicke was a member of Allegheny's board at the time. I believe that he resigned from that Board immediately the scandal was reported - but I have to wonder whether his enthusiasm for corporate service occasionally took precedence over his sense of caution...

It is indeed sad that someone with so much energy and good intentions should find themselves in this position.

Roger

Roger Collins 
UCC School of Business

January 11, 2005 reply from Bob Jensen

Hi Roger,

I track a lot of scandals in my fraud beat, and I know Bob personally. If there is one person who stands out as an innocent soul being used by the bad guys, I would have to say it is Bob Jaedicke. He is, in my viewpoint, a high integrity person and (was) a great teacher.

Firstly, I might say that Bob was a managerial accounting professor (PhD Minnesota) and an administrator (Dean at Stanford) for his entire career. He was not a noted researcher (which was not a huge tenure requirement in universities when he went to Stanford in 1961). Nor did he have a financial accounting background to deal with complex contracting such as the thousands of SPEs and derivative financial instruments frauds taking place under his nose at Enron. Secondly, in his latter years serving part time for Enron, Bob as too old and too trusting for dealing with the truly clever crooks at Enron. He did make over a million dollars during his 15-year part-time service to Enron, but this is peanuts in the grand scheme of the billions of dollars of fraud taking place under his nose.  If he was a co-conspirator, his take would have been a 100 times greater like what Enron's crooks got --- http://www.trinity.edu/rjensen/FraudEnron.htm#StockSales 

I really believe his testimony at http://energycommerce.house.gov/107/Hearings/02072002hearing485/Jaedicke798.htm  
(Although I do not think the Audit Committee was quite as up on things as he leads us to believe in that testimony. Being "aware" of special transactions does not mean that they were competently addressed by the audit committee.)

I especially think that Bob was too trusting of the auditing firm (Andersen) and Enron's legal council, both of whom were either totally incompetent or co-conspirators with Enron's management.

PS One of the members of Enron's Board who finally had to settle big time was Wendy Gramm (the wife of then powerful Senator Phil Gramm) who was, in my viewpoint, in on this up to her teeth along with her husband. It was the Gramm-deregulation of energy derivative markets that opened up many of Enron's biggest scandals, including the screwing of the western state power companies (particularly California and Washington state).  Senator Gramm first appointed  You can read more about Wendy by using the search term "Wendy" at http://www.trinity.edu/rjensen/FraudEnron.htm 

You can read the following at http://www.trinity.edu/rjensen/FraudEnron.htm 

Enron had done its homework in Washington. Help came largely from the husband-and-wife team of economists Senator Phil Gramm and his wife, Wendy. Before joining the Enron board, Wendy Gramm had exempted energy futures contracts from government oversight in 1992; her husband now pushed for the Commodity Futures Modernization Act in December 2000, which would deregulate energy trading. There was strong opposition to Phil Gramm's bill in the House, mainly from the President's Working Group on Financial Markets, who included Secretary of the Treasury Lawrence Summers; Alan Greenspan, the chairman of the Federal Reserve; and Arthur Levitt, chairman of the SEC. But Enron spent close to $2 million lobbying to combat that opposition, while Gramm kept the bill from floor debate in the waning days of the Clinton administration. He reintroduced it under a new name immediately after Bush assumed office and got his bill passed. Enron, in turn, got the opportunity to trade with abandon. No one needed to know--or could find out--how much power Enron owned and how or why the company moved it from place to place.
Power Failure: The Inside Story of the Collapse of Enron, by Mimi Swartz, Sherron Watkins, Page 227.  See "What was Enron getting for its political bribes?"

Bob Jensen

January 11, 2005 reply from Eric Press [eric.press@TEMPLE.EDU

Reading this, I can believe Jaedicke was not a crook. However, you are giving a pass to a director whom, although a good guy, was derelict in his duties to shareholders. Assuming Jaedicke's aging wits were not so addled that he realized he wasn't expert in arcane financial accounting dealings, he could have resigned from the board. I agree that a decent man's reputation was sullied by clever crooks, but lending his reputation to the crooks helped them perpetrate their fraud. That he is required to pay cash for faulty judgment doesn't seem unfair to me. Indeed, isn't this a good example to corporate directors that their fiduciary obligations are taken seriously by courts?

Eric Press

January 11, 2005 reply from Peter Kenyon [pbk1@HUMBOLDT.EDU

Bob and others,

While I agree with your observations regarding Bob Jaedicke's background, what does all this mean for the state of corporate governance in the US?

Surely Professor Jaedicke was in a better position than most board members to ask challenging questions and press for reasonable answers.

What DO we expect from board members? What is their role? What purpose do they serve?

I agree that the result for Professor Jaedicke is a personal shame and tragedy ... but the result for many other stakeholders has been worse.

Where do we go from here?

Peter Kenyon 
Humboldt State

 

January 11, 2005 reply from Corless, John [corlessj@CSUS.EDU

Isn't it high time that directors represent the shareholders instead of management? If directors are incompetent, they should refund all past director fees and disgorge all trading profits in stock. If they are conspirators, they should go to jail, along with everyone involved in the conspiracy. The real victims are the investors.

John Corless 
Professor of Accountancy CSU-Sacramento 
Sacramento, CA 95819-6088 

 

January 11, 2005 reply from Dennis Beresford [dberesfo@TERRY.UGA.EDU

Given this dialogue on directors (I'm one myself) and corporate governance I can't resist pointing out yesterday's news that the director of Yale University's Corporate Governance Institute was fired and had his tenure revoked for falsifying his expense reports. This was covered in Monday's Wall Street Journal in case you missed it.

Denny Beresford

Bob Jensen's threads on the Enron/Andersen scandals are at http://www.trinity.edu/rjensen/fraudenron.htm#EnronLinks 


"A WorldCom Settlement Falls Apart," by Gretchen Morgenson, The New York Times, February 3, 2005 --- http://www.nytimes.com/2005/02/03/business/03tele.html  

A landmark settlement last month that had 10 former WorldCom directors agreeing to pay $18 million from their own pockets to investors who lost money in the company's failure was scuttled yesterday.

The settlement fell apart after the judge overseeing the case ruled that one aspect of the deal was illegal because it would have limited the directors' potential liability and exposed the investment banks that are also defendants in the case to greater damages. The lead plaintiff in the case said it could not proceed with the settlement with that provision removed.

When the settlement was announced, it was hailed as a rare case where an investor held directors responsible for problems occurring on their watch. Because yesterday's ruling turned on one technical aspect of the settlement with the former WorldCom directors, it is not expected to deter restive shareholders from trying to make corporate board members accountable.

The ruling by Judge Denise Cote of Federal District Court in Manhattan - who is presiding over the shareholder suit against directors and executives from WorldCom, its investment banks and Arthur Andersen, its auditor - sided with lawyers for the banks, who objected to the deal almost immediately after it was announced.

The judge's ruling means that the 10 directors will remain as defendants in the case. As such, they face the possibility of paying significantly more than they had agreed to in the settlement if they are found liable by a jury for investor losses.

Federal law states that in cases involving the sale of securities, as this one does, defendants found liable for losses by a jury are responsible for the entire amount of the damages. But in 1995, the Private Securities Litigation Reform Act provided that directors involved in such a case are responsible only for their part of the fault, as determined by the jury. This law was intended to protect directors from staggering damages in such cases.

The settlement with the former WorldCom directors was unfair to the investment bank defendants, their lawyers argued, because with the board members no longer named as defendants in the case, the banks could not reduce their own liability in a verdict by the amount of the investors' losses that the jury concluded was the responsibility of the company's former directors.

For example, under the terms of the settlement, the banks would have been limited to a reduction in damages of $90 million, the estimated net worth of the directors. A jury might find the directors responsible for far less.

The settlement, had it gone through, would also have prevented the banks from being able to sue the directors and possibly recover money from them. Sixteen banks are named as defendants, including J. P. Morgan Chase, Deutsche Bank and Bank of America.

Continued in the article

Bob Jensen's threads on the Worldcom scandal are at http://www.trinity.edu/rjensen/FraudEnron.htm#WorldcomFraud 

 


"The Fall of Fannie Mae," by Bethany Mclean, Fortune, January 24, 2005 --- http://www.fortune.com/fortune/investing/articles/0,15114,1015932,00.html 

This is not your ordinary accounting fraud. Yes, there's the matter of $9 billion in overstated earnings. But the fight over Fannie is a nasty political showdown where everyone has his own agenda. And it's not over yet. By Bethany Mclean

On a sunny Monday in June 2002, President George W. Bush stood in the St. Paul AME Church in a formerly dilapidated neighborhood on the south side of Atlanta. Sitting in prime seats were Franklin Raines, the CEO of Fannie Mae, and Leland Brendsel, the CEO of Freddie Mac. The President was there to unveil an initiative aimed at helping 5.5 million minority families buy homes before the end of the decade—"Part of being a secure America," he said, "is to encourage home-ownership."

Raines and Brendsel were there because, well, encouraging home-ownership was what their congressionally chartered companies existed to do. By purchasing hundreds of billions of dollars' worth of mortgages held by banks, Fannie and its cousin Freddie made it possible for financial institutions to turn around and make more loans to prospective homeowners. Or at least that's the theory.

Franklin Delano Raines is a prominent Democrat, but that hadn't kept him from currying favor with the new Republican President. For more than 30 years Fannie Mae has straddled two worlds—business and politics—and the company placed enormous emphasis on maintaining good relations with key government officials. In 2001, Raines had written an op-ed in the Wall Street Journal lauding Bush's faith-based initiative. He had also reached out to Bush allies in the faith-based community, including Kirbyjon Caldwell, the Houston pastor who gave the benediction at Bush's first inaugural. In October 2002, at the White House Conference on Minority Home Ownership, Raines and Caldwell were both on hand to be praised warmly by Bush for their work.

It hasn't even been three years since that sunny day in Atlanta, but oh, how the world has changed. Both Brendsel and Raines have been deposed in the wake of multibillion-dollar accounting scandals. Brendsel fell in 2003, after government regulators accused Freddie Mac of understating billions in profits in an effort to smooth earnings. More recently the Securities and Exchange Commission ruled that Fannie Mae—the larger and more important of the two companies—had violated accounting rules, overstating profits by an estimated $9 billion since 2001, which represents almost 40% of its total earnings during that period. Raines, who was paid more than $90 million during his six years as CEO—much of it linked to meeting profit targets—made a last-ditch effort to save his job, but to no avail. CFO Tim Howard was also forced out. Fannie's accounting firm of 36 years, KPMG, was 

Continued in the article

Related Articles in Fortune
Fannie Mae: Less Enron, More Tyco

·Freddie Finally Gets Fingered

Bob Jensen's threads on Fannie Mae are at http://www.trinity.edu/rjensen/caseans/000index.htm#FannieMae 


Now firms must simultaneously hire three or four of the Big Four:  Is this shadows and mirrors?

"Auditors: The Leash Gets Shorter:   Providing tax services to audit clients will no longer be allowed," Business Week, December 27, 2004, Page 52 --- http://www.businessweek.com/@@5NnjCIcQuePg7RMA/magazine/content/04_52/b3914040_mz011.htm 

For years, Sun Microsystems Inc. (SUNW ) looked to its auditor, Ernst & Young International, to provide all manner of advice on other financial matters. But recently the Santa Clara (Calif.) high-tech company has started to shop elsewhere. PricewaterhouseCoopers now handles Sun's internal audit, KPMG International helps test financial controls, and Deloitte Touche Tohmatsu prepares tax returns for Sun's expatriate employees. With new federal rules beefing up the audit process, "it's our firm belief that [Ernst & Young] should focus specifically on the audit," says Stephen T. McGowan, Sun's chief financial officer.

Sun is not alone. After auditors failed to catch financial fraud at Enron and WorldCom (now MCI), Congress ordered companies to quit hiring their auditors for a slew of services, from bookkeeping to computer-systems design. The 2002 Sarbanes-Oxley corporate-reform act left it up to boards' audit committees to decide whether the same accounting firm could provide other services -- including tax advice. But with audit committees eager to avoid any chance for conflicts, more companies, from General Electric to Home Depot to American Express, are switching their tax work, too.

Now they have another reason to play it safe. On Dec. 14, the Public Company Accounting Oversight Board proposed stricter curbs on audit firms selling tax services to their clients. The board, created by Sarbanes-Oxley, says it wants to ban auditors from promoting aggressive tax shelters to client companies and their top execs. It also wants to keep them from accepting contingent fees, payments based on a percentage of their clients' tax savings. Also off limits: offering tax services to top company officers. The rules, which must be approved by the Securities & Exchange Commission, "draw clear lines to distinguish inappropriate services that impair auditor independence from permissible services that are not detrimental," says PCAOB Chairman William J. McDonough.

Investors are ahead of regulators. For the past two years, Institutional Shareholder Services, a proxy-advice service, has urged the investors it advises to vote against rehiring auditors who collect more in consulting fees than they do from the audit and audit-related work. The share of Standard & Poor's 500-stock index companies failing that test fell from 60% in 2002 to just 2% this year.

INCREASED COMPETITION The Sarbanes-Oxley restrictions, along with better disclosure, drove much of that improvement, but boards are going beyond the law's strictures. "When in doubt, I want to turn away from the audit firm for anything except auditing," says professor Paul R. Brown of the Stern School of Business at New York University, who also sits on the audit committee of French aerospace company Dassault Systèmes.

The upshot: The average amount a large U.S. company paid its auditor for tax services fell 14%, to $1.9 million, in 2003, according to a study by Glass, Lewis & Co., a proxy-research firm. Jonathan Hamilton, editor of Public Accounting Report, figures tax fees could fall 5% to 10% in 2005 if the SEC blesses the new rules.

Critics have long accused the Big Four firms of underpricing their audits so they can charge hefty fees for consulting. But as businesses pull back tax work and offer it to the competition, rates are falling. Sun, which was paying Ernst & Young $3.5 million a year for expatriate tax services, found Deloitte was willing to do the work for just under $3 million.

The Big Four aren't necessarily losing out. Audit fees are rising as accountants scrutinize financial statements more extensively, and consulting work taken from the auditor usually ends up at another Big Four firm. Still, second-tier accounting firms and lawyers are gaining. Grant Thornton International, for example, recently took on state and local tax assignments from R.R. Donnelley & Sons Co. and Marriott International Inc.

The downside to spreading the consulting work: With only four international firms to choose from, a multinational can't switch auditors without having to reshuffle consultants for its tax, info-tech, and human-resources departments. Still, investors will be better off if auditors' independence isn't compromised by fat fees for other services.

December 20, 2004 reply from Robert B Walker [walkerrb@ACTRIX.CO.NZ

An interesting story, but surely it contains a non-sequitur. In the seventh paragraph the story suggests that critics of cross-selling were wrong in claiming that there was a relationship between audit lowballing and consulting fees, citing the example of EY and Deloitte at Sun. I would have drawn the opposite conclusion - that is, the fact that the auditors no longer had privileged access for the purpose of pecuniary gain, the price fell.

As a failed auditor, having been driven from the field by predatory pricing, I now watch with some irritation the way in which the remaining mega-firms are now holding the world to ransom. Given that it is practically impossible for other accounting firms to re-enter the field, the only solution is to open the field again by allowing in other, well capitalised firms such as banks, insurers etc. I, for one, would be happy to see an audit opinion by AIG or Citibank. Frankly, whilst Mr Spitzer may have demonstrated organisations such as these lack a sense of virtue, they are relative paragons by comparison.

The law creates an insurmountable legal barrier to entry. This barrier promotes the existence of what has become an effective cartel. This would be a difficult barrier to break down as it would require the concerted efforts of a variety of national jurisdictions. However, I am sure the SEC has enough clout to make the change happen

Bob Jensen's threads on auditor independence are at http://www.trinity.edu/rjensen/fraud001.htm#Professionalism 

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


Ten former directors of WorldCom have agreed to pay $18 million of their own money to settle a lawsuit by investors.
Grechen Morgensen, The New York Times, January 6, 2004 ---
http://www.nytimes.com/2005/01/06/business/06tele.html?hp&ex=1105074000&en=b956e943855a1d2b&ei=5094&partner=homepage

"It's just extraordinarily rare for a director to pay money out of his own pocket," said Michael Klausner, a law professor at Stanford University who is studying the personal liability of directors. Mr. Klaus-ner and his fellow researchers have so far found only four cases from 1968 to 2003 in which directors contributed their own money to settle a shareholder lawsuit. "It is extremely unusual," he said. If the settlement deters people from serving on corporate boards, that will run counter to the interests of institutional investors, who have called for a greater role for independent directors in corporate governance, Mr. Klausner said. Newer laws, like the Sarbanes-Oxley Act of 2002, adopted in the wake of the Enron and WorldCom bankruptcies, are also requiring a greater role for outside directors.
Jonathan D. Glater, "A Big New Worry for Corporate Directors," The New York Times, January 6, 2005 --- http://www.nytimes.com/2005/01/06/business/06board.html
Jensen Comment:  Why should anybody be shielded by insurance if they are co-conspirators in fraud?

Bob Jensen's threads on the Worldcom scandal are at http://www.trinity.edu/rjensen/FraudEnron.htm#WorldCom


"Coziness comes back to bite auditing firms," by Andrew Leckey, Chicago Tribune, January 2, 2005 --- http://www.chicagotribune.com/business/investing/personalfinance/chi-0501020216jan02,1,5957974.story?coll=chi-businessyourmoney-hed 

No matter how elite, historic or long an auditing firm's name may be, it gets the boot when a corporation's numbers don't add up.

This fall from grace of the accounting superpowers actually began in the mid-1980s.

Known as the Big Eight, the premier firms consisted of Arthur Andersen, Coopers & Lybrand, Deloitte Haskins & Sells, Ernst & Whinney, Peat Marwick Mitchell, Price Waterhouse, Touche Ross and Arthur Young.

Every accounting major and aspiring CPA could recite those names. Accounting and management consulting were professions of high pay and prestige, especially for those on track to become partners.

But the giant numbers-crunching firms had already reached their pinnacle. They began merging, just as the many corporations they audited were doing. In 2002, only Andersen, Ernst & Young, Deloitte & Touche, KPMG and PriceWaterhouseCoopers remained of the original group.

That's the year Andersen imploded along with its failed audit client Enron. A felony conviction for obstructing justice led to the dissolving of its accounting practice. Andersen was no more.

We now enter 2005 with a Big Four that has much less independence. They are answerable to a Public Company Accounting Oversight Board named by the Securities and Exchange Commission and must follow guidelines of the Sarbanes-Oxley Act.

Each accounting giant also faces huge lawsuits that seek to tag it with responsibility for permitting corporate financial deception. If several major judgments were to come down against any one firm at once, it might signal its demise.

Meanwhile, client companies are dumping the Big Four as auditors to cut costs and gain a closer relationship with a smaller auditor. In addition, most of the Big Four have sold off or laid off their lucrative management consulting operations.

For large corporate clients, the finite number of huge accounting firms with the capacity to handle their business makes it difficult to replace auditors. They also can't audit firms that already provide them with non-audit services.

Corporations and their auditors are in a fix, but a fix of their own making. The cozy relationship that benefited both parties over decades set the table for financial disasters that penalized shareholders and employees.

The fall from grace of the elite accounting firms was in some ways justified. Now the entire accounting profession must unite to prove that accurate reporting is a higher priority for them than privilege or fat billings.

Bob Jensen's threads on auditor independence are at http://www.trinity.edu/rjensen/fraud001.htm#Professionalism 

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


Ernst & Young already has put into effect changes to the way it audits savings-and-loan associations that comply with the OTS consent order, the firm said. "And we are voluntarily taking the extra step of implementing these changes throughout our bank audit practice," said Charles Perkins, a spokesman in New York.

 

"Ernst & Young Settles Charges For $125 Million," The Wall Street Journal, December 27, 2004, Page B3 --- http://online.wsj.com/article/0,,SB110411348322509799,00.html?mod=todays_us_marketplace 

Ernst & Young LLP, one of the four largest U.S. accounting firms, agreed to pay a total of $125 million to settle U.S. claims arising from its audits of a failed Illinois savings bank.

Under a consent order agreed to with the Office of Thrift Supervision, the New York-based partnership will pay the Federal Deposit Insurance Corp. $85 million as receiver for the failed Superior Bank FSB. In addition, Ernst & Young will pay $40 million in restitution to the FDIC, which insures deposits at the 9,025 U.S. banks and savings-and-loan associations, said an FDIC spokesman.

Superior was declared insolvent in July 2001 after running into trouble over its loans to borrowers with spotty credit records. At the time of its failure, Superior had assets of about $2 billion. The FDIC sued Ernst & Young in 2002, contending that it delayed alerting regulators to improper accounting practices at the thrift out of concern that negative publicity could disrupt the sale of its consulting unit.

In April 2003, a federal judge dismissed the suit, saying the FDIC wasn't able to sue in its capacity as administrator for the government's Bank Insurance Fund and Savings Association Fund. The FDIC appealed the decision.

Ernst has disputed allegations that it was to blame for the bank's failure, citing testimony in 2002 before the Senate by the FDIC's inspector general that Superior Bank's failure was "directly attributable" to "the bank's board of directors and executives ignoring sound risk-management principles."

In settling, Ernst & Young didn't admit or deny that its audits failed to comply with any professional accounting standards. It said the decision to settle underscored a commitment to work cooperatively with regulators and to make sure the firm had "the strongest policies and procedures to serve our clients and the public interest."

Ernst & Young already has put into effect changes to the way it audits savings-and-loan associations that comply with the OTS consent order, the firm said. "And we are voluntarily taking the extra step of implementing these changes throughout our bank audit practice," said Charles Perkins, a spokesman in New York.

Bob Jensen's threads on the legal woes of Ernst & Young are at http://www.trinity.edu/rjensen/fraud001.htm#Ernst 


Unethical Stock Brokers, Bankers, and Investment Advisors in Every Small Town

One of the most unethical things stock brokers, bankers,  and investment advisors can do is to steer naive customers into mutual funds that pay the brokers kickbacks rather than suitable funds for the investors.  The well known and widespread brokerage firm of Edward Jones & Co. to pay $75 million to settle charges that it steered investors to funds without disclosing it received payments.  Add this to banker's pretenses at being independent dispensers of "fair" advice and you have a rottenness all the way to the core of small towns.


Surprise! Surprise!

"Claim Says Morgan Stanley Got  Kickbacks to Push Some Products," by Susanne Craig and Ian McDonald, The Wall Street Journal, January 7, 2004, Page C3 --- http://online.wsj.com/article/0,,SB110505182475219324,00.html?mod=home_whats_news_us

A new arbitration claim asserts that Wall Street firm Morgan Stanley received hidden incentives from several big insurance companies to push certain variable annuities and other investment products.

"Rather than placing the interests of their customers first -- as it is required to do -- Morgan Stanley put its interests first by acting in a manner that was designed to maximize the kickbacks it received under [a] distribution agreement," lawyer Ron Marron alleges in a complaint filed on behalf of a client he says bought two variable annuities from Hartford Financial Services Group Inc. that performed poorly and were unsuitable for the client's needs. He says Morgan was motivated to sell his client this product because of undisclosed payments the firm was getting.

A Morgan Stanley spokesman said the complaint is "wholly without merit. We're confident that the compensation arrangements covering these products have been appropriately disclosed." He said there is language in prospectuses that the firm believes constitutes disclosure. Hartford declined to comment.

This latest arbitration filing is believed to be among the first that zeroes in on alleged abuses in the sale of variable annuities, which are part insurance, part investment. The buyer, or contract-holder, invests money among various mutual-fund-like portfolios in tax-deferred accounts. The "insurance" consists of a stream of income the buyer receives from the account in retirement and a so-called death benefit paid to the contract holder's heirs. There is more than $1 trillion invested in variable annuities, according to the National Association for Variable Annuities.

The potential conflict of interest from brokers' hidden financial incentives to sell some investments over others has been an issue for some time. To get a spot on brokerages' preferred lists of mutual funds, for example, many fund firms strike "revenue sharing" deals by which a fund company pays brokerage firms a percentage of the sales the brokers bring in, on top of the commissions that investors pay.

For mutual-fund firms, these deals are a way to stand out from the ocean of choices available. Brokerages say these fees help cover the costs of marketing funds, but critics say they give broker incentives to sell funds that are more profitable for the firm and not necessarily the best choice for a given client.

Such arrangements are legal as long as they are properly disclosed. Late in 2003, Morgan Stanley paid $50 million to settle civil charges levied the by Securities and Exchange Commission that the firm failed to tell clients that it paid brokers more if they sold funds offered by 14 firms whose extra payments earned them a spot on the firm's preferred list of funds.

Mr. Marron's claim about variable annuities, filed in late December with the National Association of Securities Dealers, alleges, among other things, that Morgan Stanley entered into secret "distribution agreements" with various insurance companies through which Morgan Stanley got money for steering its clients into certain insurance products. The NASD said yesterday it is aware of the claim and it is looking into the matter.

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


The SEC is assessing whether fund managers are pocketing rebates on stock-trading commissions that should go back to investors.
"
SEC Examines Rebates Paid To Large Funds ," by Susan Pulliam and Gregory Zuckerman, The Wall Street Journal, January 6, 2005, Page C1 --- http://online.wsj.com/article/0,,SB110496678233318071,00.html?mod=home_whats_news_us

The Securities and Exchange Commission has launched a broad examination of whether managers of big mutual funds and hedge funds are pocketing rebates on stock-trading commissions that should be directed back to investors, people familiar with the matter say.

The move is the latest in a series of efforts by federal regulators to stamp out possible improper payments received by favored Wall Street clients for trading business.

At issue are commissions that these large investors pay to Wall Street firms to execute stock trades. Typically, the funds pay commissions totaling as much as five cents a share. But part of these commissions -- two cents or so -- sometimes is sent back to money-management firms in the form of rebates, depending on how much business they generate for the Wall Street firms, and how much they pay for services such as stock research, among other things.

This practice isn't improper if it is disclosed and the rebates benefit fund holders. The SEC is seeking to find out whether some money managers, including hedge-fund managers, have used any kinds of rebates to enrich themselves or their firms, or to pay for items that don't benefit fund holders, the people say.

"It's something that's talked about in the business. Some hedge funds don't put that rebate back into their funds, but rather keep it for themselves," says David Moody, a lawyer at Purrington Moody LLP in New York who represents hedge funds. "If a rebate is going to the fund manager, and not the fund, that is a big deal. It's not the fund manager's money."

The issue is significant for fund holders, particularly in an era of slimmer gains in the stock market. Money managers pay huge commissions to Wall Street. Last year, hedge funds alone paid at least $3 billion in commissions, estimates Richard Strauss, an analyst at Deutsche Bank. Though it is unclear how much of these commissions were rebated, even a sliver going into the pockets of fund managers could amount to large sums of money lost by investors.

The examination into rebate practices is part of a broader effort by regulators to curb abuses relating to how Wall Street rewards privileged clients. The National Association of Securities Dealers and the SEC recently launched an investigation into gifts and business entertainment awarded by Wall Street to its best clients. That investigation has led to disciplinary actions by firms against 14 trading employees at mutual-fund companies and elsewhere. Meanwhile, the SEC's enforcement chief, Stephen Cutler, and Lori Richards, head of examinations at the SEC, long have been interested in the issue of trading commissions paid by money managers, particularly hedge funds.

Commission rebates are the latest in a string of longstanding industry practices now under regulatory scrutiny. On the heels of sweeping investigations by New York Attorney General Eliot Spitzer, the SEC has begun to open broad investigations into entire industries when evidence of problems surface, even if they initially appear isolated. Last year, as part of this initiative, the SEC began looking at oil-company reserve accounting after problems surfaced at Royal Dutch/Shell Group.

Continued in article

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


"Audit Faults Accountant in Roslyn School Scandal," by Bruce Lambert, The New York Times, January 7, 2004 --- http://www.nytimes.com/2005/01/07/nyregion/07roslyn.html?oref=login

A new state audit concludes that the accounting firm chosen by the Roslyn school district as its fiscal watchdog was hired without competitive bidding, had a blatant conflict of interest in the sale of financial software to the district, grossly neglected basic duties like reviewing canceled checks and failed to catch rampant multimillion-dollar corruption - even after a whistleblower's tip on thefts of $223,000

The withering critique could have implications far beyond Roslyn. The accounting firm, Miller, Lilly & Pearce of East Setauket, has also been the independent auditor for 54 other school systems in New York State, including more than a third of Long Island's districts and three upstate, and for several local governments and nonprofit groups.

State Comptroller Alan G. Hevesi, who released his staff's report at a news conference here Thursday, said he had no evidence of major problems in other schools but was alerting all 701 districts across the state.

So far in Roslyn's growing scandal, three people have been arrested and charged with defrauding the district of more than $2.3 million, though investigators predict the ultimate amount could be several times that. Those arrested are the fired school superintendent, Frank Tassone; the former business manager, Pamela Gluckin; and her niece, a former accounting clerk, Debra Rigano.

The accountants hired to detect and prevent fraud utterly failed, Comptroller Hevesi said.

"The work of Miller, Lilly & Pearce was so appallingly inadequate that it would shock anyone associated with the auditing profession and certainly the taxpayers who depend on the firm to safeguard their money," he said. "This is just an awful performance by this auditor. They are unprofessional.

"The fraud was so pervasive that it would have taken significant effort not to uncover it. Even a rudimentary review of disbursements and canceled checks would have revealed many instances of wrongdoing."

Continued in article

 Bob Jensen's threads on auditor professionalism and independence are at http://www.trinity.edu/rjensen/fraud001.htm#Professionalism

Bob Jensen's threads on scandals in all firms apart from the Big Four are at http://www.trinity.edu/rjensen/fraud001.htm#BigFirms


"Ex-Officials at AOL, PurchasePro Face Charges in Accounting Probe," by Brian Blacksone, The Wall Street Journal, January 10, 2005 --- http://online.wsj.com/article/0,,SB110538222416621755,00.html?mod=home_whats_news_us 

Two former midlevel America Online officials and four former PurchasePro.com executives were indicted Monday on federal charges for their alleged roles in schemes to help the smaller Internet company inflate earnings.

The indictment filed by the U.S. Attorney for the Eastern District of Virginia charges the executives with a scheme to fraudulently increase revenue by PurchasePro and AOL's business affairs and interactive marketing units. AOL is a unit of Time Warner Inc.

Kent Wakeford, a former executive director at AOL's business affairs unit, was charged with two counts of securities fraud, two counts of making false statements, and 17 counts of wire fraud. John Tuli, a former vice president in AOL's NetBusiness unit, was charged with two counts of securities fraud and making false statements and five counts of wire fraud.

Charles Johnson, Christopher Benyo, Joseph Kennedy and Scott Wiegand -- all formerly of PurchasePro -- were charged with securities and wire fraud and other charges.

In addition to Monday's indictment, the Securities and Exchange Commission filed civil actions against Messrs. Wakeford, Tuli, Johnson, Benyo and Kennedy.

At the time of its relationship with AOL, PurchasePro sold computer software including business-to-business licenses that allowed companies to buy and sell products on the Internet. PurchasePro and AOL had an agreement that allowed AOL to earn revenue from the sale of those licenses.

Last month, Time Warner agreed to pay $510 million related to accounting problems at its AOL unit. The same day, the Justice Department filed criminal charges related to AOL and PurchasePro.

Government prosecutors alleged that the two companies overstated revenue by at least $65 million during 2000 and 2001.

"It's a story of trying to create the appearance of success in business that just wasn't there," said Paul McNulty, U.S. attorney for the Eastern District of Virginia. "The investing public must have accurate information to make sound decisions. These defendants swindled the investing public," he added.

The defendants face a maximum 20 years in prison and a $250,000 fine for the conspiracy count. Each count of securities fraud carries a maximum 10 years in prison and $1 million fine. Each wire fraud and each false statement count carries maximum five year prison terms and $250,000 in fines. The obstruction charge carries a maximum 20 years in prison and a $250,000 fine.

"6 Former Net Executives Indicted in Conspiracy Case," by Saul Hansell, The New York Times, January 11, 2005 --- http://www.nytimes.com/2005/01/11/technology/11aol.html 

Painting a picture of a desperate conspiracy to prop up a failing Internet company, a federal grand jury yesterday indicted four former top executives of PurchasePro.com, a defunct dot-com, and two former midlevel executives of America Online.

The indictment states that AOL and PurchasePro worked out a complex deal that was meant to inflate the revenues of both companies before PurchasePro began to collapse in 2001 amid recriminations.

. . . 

By early 2001, executives from both companies became increasingly frantic as it became clear that AOL was not able to produce enough customers for PurchasePro, the indictment says. Mr. Johnson, PurchasePro's chief executive at the time, spent two weeks working in the New York offices of Mr. Wakeford, the AOL business affairs executive, as they tried to persuade AOL customers, including some of the most prominent companies in the country, to buy PurchasePro software, according to the indictment.

Eventually, AOL offered to give some companies discounts if they would buy PurchasePro software, the indictment says. For example, Cisco Systems bought software from PurchasePro for $440,000, and AOL deducted exactly that amount from its $5 million advertising bill.

According to the indictment, in March 2001, Mr. Johnson gave Mr. Wakeford a check for $12.2 million, representing a commission for AOL's help in selling Purchase Pro's software. After Mr. Johnson took the check back later that day, Mr. Wakeford sent him an e-mail message saying that an unnamed senior AOL executive was now "knee deep in blood" and would fly in the next day and track Mr. Johnson down at his hotel, the indictment says.

Mr. Johnson wrote back to Mr. Wakeford the same day, criticizing AOL for not living up to its pact, according to the indictment, but also said that "I pray this can be resolved because I enjoy the relationship and that is why I sold my soul."

According to the indictment, PurchasePro, with the help of the AOL executives, committed securities fraud by misleading the public about its revenue.

In March 2001, Mr. Johnson issued a news release saying PurchasePro's revenue for the first quarter would be $42 million. In April, it said that its revenue was $29.8 million. But by May, its filing with the Securities and Exchange Commission showed revenue of $16.02 million.

That same month, Mr. Johnson resigned as chief executive, and in 2002, PurchasePro filed for bankruptcy protection.

Continued in article

 

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


"Opinions Labeling Deals 'Fair' Can Be Far From Independent," by Ann Davis and Monica Langley, The Wall Street Journal, December 29, 2004 --- http://online.wsj.com/article/0,,SB110427249753011370,00.html?mod=home%5Fpage%5Fone%5Fus 

Banks That Do Them Often Are Advisers on Transactions And Have Fees at Stake A High-Profit-Margin Item 

In the biggest U.S. merger this year, J.P. Morgan Chase & Co. announced last January it would acquire Bank One Corp. To assure investors it was paying a fair price, J.P. Morgan told them in a proxy filing it had obtained an opinion from one of "the top five financial advisors in the world."

Itself.

The in-house bankers at J.P. Morgan endorsed the $56.9 billion price -- negotiated by their boss -- as "fair."

But during the negotiations, Bank One Chief Jamie Dimon had suggested selling his bank for billions of dollars less if, among other conditions, he immediately became chief of the merged firm, according to a person familiar with the talks. That suggestion wasn't accepted by J.P. Morgan.

To some J.P. Morgan shareholders who are now suing over the deal, it raises the question: Did Morgan's in-house evaluators endorse a higher price to keep CEO William Harrison in power longer? "Only by retaining a conflicted financial adviser could Harrison control the process and justify paying more than was necessary for Bank One," the investors said, in a pending suit in Delaware Chancery Court.

J.P. Morgan denies that assertion, according to a spokesman, who said that executives at the bank would have no comment. J.P. Morgan, which had disclosed its use of an in-house advisory team, says it made sense to use bankers intimately familiar with its business, and that the board's lawyers said it wasn't necessary to get another opinion. The bank says it negotiated the best deal possible given that it didn't want to hand immediate control to a newcomer. It also says that other shareholders -- from Bank One -- have sued claiming the price was unfairly low.

Boards of directors get "fairness opinions" to show they've independently checked out the price of a deal, thus giving themselves some legal protection from unhappy shareholders. But it is an open secret on Wall Street that fairness opinions can be anything but arm's-length analyses.

Investment bankers frequently write fairness opinions for clients with whom they have longstanding business ties and with whom they hope to continue having relationships. Indeed, an opinion is commonly written by the very bank that suggested the merger or acquisition in the first place -- and that now is acting as adviser on that deal.

In such cases, the investment bank stands to collect a far larger fee if the deal goes through than if it does not. If it goes through, the advisory bank will collect a "success fee" that dwarfs the opinion fee. And, in a further incentive to bless high-priced deals, the success fee is usually tied to the deal's price.

As if these potential conflicts weren't enough, when the merging parties are financial firms, the parties typically get their fairness opinions not from outsiders but from folks right down the hall.

Now, securities regulators may weigh in. The National Association of Securities Dealers has launched an enforcement inquiry into conflicts that can arise with fairness opinions. The NASD is also seeking comment on potential new rules requiring more disclosure of the financial incentives that bankers and their clients have for endorsing deals. There isn't any move to do away with the opinions.

Fairness opinions often vet prices that were set by company executives who, the bankers know, have strong financial incentives to push through a deal. The opinions often are crafted at the last minute, as bleary-eyed bankers scramble to cobble together projections to justify the final price at an impending board meeting or news conference.

In the case of Bank of America Corp.'s recent purchase of FleetBoston Financial Corp., Bank of America called in Goldman Sachs Group as adviser the weekend before the deal was announced. Goldman got $25 million for providing advice, including $5 million for a fairness opinion. Morgan Stanley, which advised Fleet, also collected $25 million, an undisclosed part of it for its fairness opinion. The $47.7 billion deal closed April 1.

"Fairness opinions are one of the highest profit margin businesses on Wall Street. In the BofA-Fleet deal, profitability must surely be setting new heights," said Thomas Brown, a hedge-fund manager with a Web site that follows bank stocks, in a column after the deal was announced. Believing that BofA overpaid, Mr. Brown contended that "the large dollar payment was necessary to get the names of two prestigious firms to provide fairness opinions on a questionable transaction."

Continued in the article

Bob Jensen's threads on frauds of bankers, brokers, and investment advisors are at http://www.trinity.edu/rjensen/fraudRotten.htm 

Bob Jensen's threads on derivative financial instruments fraud by these same players are at http://www.trinity.edu/rjensen/fraudRotten.htm#DerivativesFrauds 


The action against Jones represents the first on 529 plans as part of a NASD sweep of 20 brokerage firms that sell the college-saving accounts. Regulators are concerned that secret payments are leading parents into higher-cost or worse-performing options. And, in some cases, investors aren't being told that they could get state income-tax breaks in certain states, such as New York
Laura Johannes and John Hechinger, and Deborah Solomon (See Below)

The sad part is that many people who want mutual funds can get straight forward information from reputable mutual funds like Vanguard and avoid having to pay a financial advisor anything and avoid the risk of unethical advice from that advisor.

"Edward Jones Agrees to Settle Host of Charges," by Laura Johannes and John Hechinger, and Deborah Solomon, The Wall Street Journal, December 21, 2004, Page C1 --- http://online.wsj.com/article/0,,SB110356207980304862,00.html?mod=home_whats_news_us 

Edward D. Jones & Co. agreed to pay $75 million to settle regulatory charges that it steered investors to seven "preferred" mutual-fund groups, without telling the investors that the firm received hundreds of millions of dollars in compensation from those funds.

The settlement, tentatively agreed to by the Securities and Exchange Commission, the National Association of Securities Dealers and the New York Stock Exchange, represents the largest regulatory settlement to date involving revenue sharing at a brokerage house, an industry practice in which mutual-fund companies pay brokerage houses to induce them to push their products.

Even so, California Attorney General Bill Lockyer called the settlement "inadequate" given payments from the funds that he said totaled about $300 million since January 2000, and declined to join it and filed a civil lawsuit against Edward D. Jones yesterday in Sacramento County Superior Court.

Mr. Lockyer called Edward D. Jones "the most egregious example we have reviewed so far" of secret revenue-sharing arrangements. California's suit, if it reaches trial, could seek repayment of the entire amount the brokerage house received, plus the "hundreds of millions" lost by investors who were sold inferior funds, Mr. Lockyer said.

Edward D. Jones, of St. Louis, has nearly 10,000 sales offices nationally, comprising the largest network of brokerage outlets in the U.S. Its revenue-sharing practices were the subject of a page-one article in The Wall Street Journal in January. In a statement yesterday, the company said it will "take immediate steps to revise customer communications and disclosures." Edward D. Jones said it has neither admitted nor denied the regulators' claims. The company added it "intends to vigorously defend itself" against the charges brought by the California attorney general.

Continued in article

Also see http://www.nytimes.com/2004/12/21/business/21fund.html 

Edward D. Jones brokers won points toward resort trips for selling funds from firms that paid Jones secret fees, the SEC said.

Fraud in College Savings Account Plans Known as 529 Plans
"SEC Divulges Details Of How Edward Jones Pushed Mutual Funds," by Laura Johannes and John Hechinger, The Wall Street Journal, December 23, 2004, Page C1 --- http://online.wsj.com/article/0,,SB110375449642307605,00.html?mod=home_whats_news_us 

Edward D. Jones & Co. brokers were awarded points toward trips to Caribbean and European resorts for selling customers mutual funds from firms that were secretly making cash payments to the brokerage house, the Securities and Exchange Commission said.

The SEC made final a $75 million settlement agreement, first disclosed Monday (see article), in which the commission said Edward D. Jones accepted tens of millions of dollars in secret fees from seven preferred fund groups, potentially tainting the Jones brokers' investment advice to customers in favor of those funds.

The money will go to reimburse investors, who the regulators contend were harmed because they didn't know their brokers might be unduly influenced by bonuses and other incentives to sell the preferred funds. The New York Stock Exchange and the National Association of Securities Dealers joined with the SEC in the regulatory action and settlement agreement.

The trip contest was one of several new details of Jones practices disclosed in an SEC order issued yesterday. According to the SEC, Jones ran sales contests twice a year, sponsored by preferred mutual-fund firms, which then got exclusive access to Jones representatives during the trips. Brokers could stay in five-star accommodations and were treated to fine dining, skiing and tours, federal regulators said. Normally, sales of all mutual funds counted toward contest points, according to the SEC order, but for 90 days in the fall of 2002, only a "subset" of the preferred funds counted toward contest points, which could be used for trips to Davos, Switzerland; Biarritz, France; the Caribbean islands of St. Martin and Tortola; and other locations.

In the 12-page order, regulators also took Edward Jones to task for promoting college-savings plans offered only by the fund families that made the secret payments. These popular savings vehicles, known as 529 plans, let parents save money for college without paying taxes on investment income or withdrawals, as long as the money is used for college expenses. Investment firms manage the plans on behalf of state governments.

Edward D. Jones said it offered 14 different 529 plans, but, in fact, it sold only three, those from American Funds, Hartford Mutual Funds Inc. and Marsh & McLennan Cos.' Putnam Investments, according to people familiar with the matter. Two of those companies -- the managers of the American and Putnam funds -- made additional revenue-sharing payments so brokers would steer clients to the plans they manage, these people said.

The action against Jones represents the first on 529 plans as part of a NASD sweep of 20 brokerage firms that sell the college-saving accounts. Regulators are concerned that secret payments are leading parents into higher-cost or worse-performing options. And, in some cases, investors aren't being told that they could get state income-tax breaks in certain states, such as New York

Continued in article

"Regulators Find Problem Trading At Edward Jones," by Susanne Craig and John Hechinger, The Wall Street Journal, December 29, 2004, Page C1 --- http://online.wsj.com/article/0,,SB110426846698811278,00.html?mod=home%5Fwhats%5Fnews%5Fus 

Firm Acknowledges to Government
That It Failed to Disclose Practices
Leading to Penalty and Shake-Up

In late 2003, St. Louis brokerage house Edward D. Jones & Co. took out advertisements in newspapers across the country, shaking its finger at the "anything goes" approach that led to abuses in the mutual-fund industry. Now, the company has acknowledged to the Justice Department that it failed to disclose mutual-fund sales practices that led to a $75 million penalty from regulators and a shake-up in its executive suite.

In a Securities and Exchange Commission filing late Monday, Jones also disclosed that regulators had found thousands of instances of the firm's improperly allowing mutual-fund trades made after 4 p.m. Eastern time to receive that day's price. The practice, called late trading, is considered one of the more clear-cut and egregious abuses of the mutual-fund scandal because it can allow favored clients to skim profits from long-term investors.

Regulators didn't identify any specific instances of abusive late trading, but said Jones didn't have the proper systems in place to prevent "any unlawful late trading that may have existed." Jones settled these allegations without admitting or denying them.

The firm, which operates the largest network of retail brokerage offices in the U.S., also disclosed in the SEC filing that Doug Hill, its managing general partner, who signed the ad, is stepping down at the end of 2005 in the wake of a settlement with federal regulators over the tens of millions of dollars in undisclosed fees the firm received from mutual-fund companies to push their products.

A spokeswoman for Jones declined to comment on the filing. Yesterday, Mr. Hill's lawyer said that his client, who declined to comment, was committed to restoring the firm's image. He added that Jones never considered what it was doing to be questionable.

Federal regulators say Jones improperly encouraged its brokers to steer customers toward seven "preferred" mutual-fund companies that secretly paid the brokerage house. That practice, common in the industry, is called "revenue sharing." Jones' revenue-sharing practices were the subject of a page-one Wall Street Journal article in January 2004. Historically, 95% to 98% of Jones sales of mutual funds have been from these funds, regulators found.

Regulators believe undisclosed payments may have hurt clients because brokers had an incentive to put them into inferior or inappropriate products just to get the incentives, which included trips, with an average value of $5,000, to destinations such as Davos, Switzerland, and the British Virgin Islands. Some brokers were provided $1,000 cash for one trip billed as a "shopping spree."

The filing by Jones, a private partnership, included a laundry list of other infractions, including findings that the firm failed to preserve e-mails for at least two years as required by regulators. The filing also included the firm's agreement with the U.S. attorney's office for the Eastern District of Missouri, which had been conducting a criminal investigation of Jones and found that the firm gave inaccurate statements to the SEC in response to a so-called Wells notice. Wells notices warn that regulators may file civil charges and give firms a chance to defend themselves. As part of the agreement with the U.S. attorney, Jones acknowledged making inaccurate statements.

The documents didn't spell out those statements, but people familiar with the matter say U.S. Attorney James Martin's office took exception to Jones's vigorous defense of its revenue-sharing agreements in its Wells response. The spokeswoman for Jones declined to comment, as did Mr. Martin.

Continued in article

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


Channel Stuffing With Donuts

 

From The Wall Street Journal Accounting Weekly Review on January 7, 2005

TITLE: Fresh Woes Batter Krispy Kreme 
REPORTER: Mark Maremont and Rick Brooks 
DATE: Jan 05, 2005 
PAGE: A3 
LINK: http://online.wsj.com/article/0,,SB110484914816116399,00.html  
TOPICS: Accounting, Auditing, Channel Stuffing, Debt Covenants, Lease Accounting

SUMMARY: Krispy Kreme has found errors in the way the company has treated payments to franchisees who were formerly employees and in its lease accounting. As well, there may be corrections stemming from alleged channel stuffing practices.

QUESTIONS: 
1.) Describe the nature of Krispy Kreme's operations. In your answer, define the terms franchisor and franchisee.

2.) Why did Krispy Kreme make payments to a former franchisee? What is the problem with the accounting for this treatment? Why does the author say that the amount was treated in a way that wouldn't have "cut into net income"?

3.) Why do you think Krsipy Kreme enters into leasing transactions? What issues could arise in the accounting for these leases? Describe all that you can think of based on your understanding of leasing transactions.

4.) What are debt covenants? What covenant has Krispy Kreme violated? Do you think that Krispy Kreme's lenders will waive this debt covenant? Why or why not?

5.) Why do you think Krispy Kreme has guaranteed its franchisees debt? What factors indicate that Krispy Kreme may be called on to make payments under some of these guarantees? Why may they have difficulty making these payments?

6.) As an analyst, how would you assess the likelihood that Krispy Kreme will be able to cover required cash payments for its own operations and for these guarantees of franchisees' debt. Specifically state what information you might use from published financial statements and where in those statements you would look for that information.

7.) What is "channel stuffing"? If the allegations of channel stuffing hold true, what adjustment should Krispy Kreme make to the sales recorded under these transactions? What audit steps can an auditor take to uncover sales transaction booked under "channel stuffing" practices?

Reviewed By: Judy Beckman, University of Rhode Island

Bob Jensen's threads on channel stuffing are at http://www.trinity.edu/rjensen/ecommerce/eitf01.htm#ChannelStuffing 

 


"Fresh Woes Batter Krispy Kreme:  Doughnut Firm to Restate Results, Delay SEC Filing; Shares Take a 15% Tumble<" by Mark Maremong and Rick Brooks, The Wall Street Journal, January 5, 2005, Page A3 --- http://online.wsj.com/article/0,,SB110484914816116399,00.html?mod=todays_us_page_one 

 

Krispy Kreme Doughnuts Inc., disclosing fresh accounting woes, said it will restate its fiscal 2004 results as it delayed indefinitely the filing of financial statements.

Hardest hit in the restatements is expected be the 2004 fiscal fourth quarter ended Feb. 1, when correcting accounting errors will cut previously reported net income by as much as 26%, the company said. The Winston-Salem, N.C., company said it won't immediately restate while it awaits the outcome of investigations being conducted by the Securities and Exchange Commission and a special committee of Krispy Kreme's board.

In addition, the doughnut company said its failure to file financial reports will trigger a default on its main credit facility Jan. 14. It added that it was in talks with its lenders for a waiver to terms called for in that agreement.

The latest disclosures sent Krispy Kreme shares down $1.83, or 15%, to $10.48, in 4 p.m. composite trading on the New York Stock Exchange. Krispy Kreme shares lost 66% last year, and are well down from their closing high of $49.37 in August 2003.

Krispy Kreme, once one of the hottest names in fast food, has been battered in recent months by a sudden slowdown in sales growth and multiple investigations of its accounting practices and franchisee acquisitions. It said yesterday that errors related to these acquisitions would be corrected by the fiscal 2004 restatement. Krispy Kreme also warned that other restatements for more recent and prior-year periods are likely.

Continued in article

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

This might be a good assignment for students.

Question
Why do firms issue preferred shares and what is the cost/benefit to common shareholders?

Answer

"Fannie Mae Agrees to Sell Preferred Stock," by Eric Dash, The New York Times, December 30, 2004 --- http://www.nytimes.com/2004/12/30/business/30place.html?oref=login  

Fannie Mae the nation's largest buyer of mortgages, said yesterday that it agreed to sell $5 billion of preferred stock to large institutional investors in a rush to meet its regulator's minimum capital requirements.

The company is selling two types of preferred stock, allowing it to make up an estimated $3 billion shortfall to satisfy the minimum capital standards imposed by the regulator, the Office of Housing Enterprise Oversight. The regulator, known by its acronym Ofheo, determined last week that Fannie Mae would be "significantly undercapitalized" once it restates its earnings by an estimated $9 billion to correct problems with the way it accounted for derivatives over the last three and a half years.

"The placement of preferred stock is a key component of Fannie Mae's capital restoration plan," said Donald B. Marron, a Fannie director and a former chief executive of Paine Webber, who has been working with Ofheo since November on ways to increase the company's capital reserves. Because Fannie Mae is currently undercapitalized, the company must get Ofheo's approval on virtually all decisions that might alter its capital reserves.

The stock issuance is the latest in a series of steps by Fannie Mae to regain the confidence of Ofheo, which has pressed for major changes at the company since it issued a scathing report on its accounting practices last fall. Last week, Fannie Mae's independent board members ousted Franklin D. Raines, its influential chairman and chief executive, and also forced out its chief financial officer, J. Timothy Howard, and its outside auditor, KPMG, after the Securities and Exchange Commission had found that the company violated accounting rules.

Earlier this fall, the board reached an agreement with Ofheo to raise its capital reserves by 30 percent, or about $9 billion, and it has been working with the regulator to draw up plans to meet those higher requirements by June.

The infusion of $5 billion, the largest amount Fannie has raised through the private sale of preferred equity, will create a capital cushion large enough for now. But Fannie Mae must still come up with about $7 billion more over the next six months, even as questions persist about its future direction persist.

"The challenges are immense for this company," said Paul Miller, an analyst with Friedman Billings Ramsey of Arlington, Va. "There are just too many unknowns and challenges and we don't know what the overall going-forward philosophy is going to be."

Fannie Mae continues to be investigated by Ofheo, the Justice Department and the S.E.C., and it faces a groundswell of pressure from critics on Capitol Hill who have sought tighter regulatory restrictions on the government-sponsored housing corporations. Fannie's board will be looking for a permanent chief executive and chief financial officer and will be improving internal controls. It must also hire a new auditor, which will have to fix existing problems and will probably not be able to release new results for several years.

"These would be issues that buyers would take into consideration," said John J. Kriz, an fixed-income analyst who follows Fannie Mae for Moody's Investors Service.

Shares of Fannie closed yesterday up 54 cents, at $70.38. Earlier in the day, Fannie Mae said it was seeking to sell $4 billion of preferred stock, and the stock fell sharply. But it quickly rebounded amid talk that there was strong demand for a preferred stock offering. After the stock market closed, the company said it had agreed to sell a total of $5 billion in two offerings arranged by Lehman Brothers.

Preferred stock is a type of equity that shares many of the properties of debt as the companies make regular dividend payments. Fannie Mae issued $2.5 billion in securities that can be converted into Fannie Mae common stock. The company also issued $2.5 billion worth of nonconvertible preferred shares with a floating rate that adjusts quarterly.

The quick sale agreement, analysts said, was a testament to its large size and the widely held assumption that the federal government stands behind the company.

"It's a well-known company, it has a government charter, and it kicks off a lot of cash," Mr. Miller, of Friedman Billings, said.

But the sale is also a sign that Fannie has newfound respect for its regulator. "For years, Fannie Mae attacked its regulator and disparaged the regulator while nominally accepting its claims," said Thomas H. Stanton, who has written two books which argued that Fannie Mae and other government-sponsored finance companies were undercapitalized. "I think that it is very good that Fannie Mae is finally taking those issues seriously."

Many analysts believe that the company will be able to raise the additional $7 billion or so to comply with the higher capital standards. The company currently retains between $2 billion and $3 billion in earnings each quarter and it could also sell part of its portfolio holdings to raise additional funds. But yesterday's agreement to sell preferred stock reduces the threat to the company's future dividends.

Continued in article


From The Wall Street Journal Weekly Accounting Review on January 7, 2005 

TITLE: 
Fannie Mae to Select Deloitte to Succeed KPMG as Auditor 
REPORTER: Jonathan Weil 
DATE: Jan 05, 2005 
PAGE: B3 
LINK: Print Only 
TOPICS: Auditing, Auditing Services, Auditor Changes, Auditor Independence

SUMMARY: Fannie Mae's financial statements have been found to contain material misstatements, primarily due to inappropriate accounting for derivatives, and it has selected a new auditor. The original assessment of inappropriate accounting was made by the Office of Federal Housing Enterprise Oversight (OFHEO) and was confirmed by a Securities and Exchange Commission (SEC) ruling last month. Deloitte & Touche assisted OFHEO in its work on assessing Fannie Mae's accounting practices.

QUESTIONS: 
1.) Why is Fannie Mae selecting a new auditor? Describe the events leading up to this change. In your answer, describe the purpose of Fannie Mae and briefly explain how it operates. (You may refer to the related article to develop your answer to this question.)

2.) Was Fannie Mae clear in describing its reasons for selecting this audit firm? Explain. What were the probable reasons that Fannie Mae chose Deloitte and Touche to serve as its next auditor?

3.) Why are the number of firms from which Fannie Mae could choose to serve as auditor so small? What do you think is the impact of the few number of large public accounting firms on the auditing profession?

4.) Do you think that Fannie Mae could choose from among more firms than those that are discussed in the article? From the perspective of any audit firm, describe the business risks associated with taking on the Fannie Mae audit.

5.) How would you describe the nature and extent of the audit procedures the Deloitte and Touche audit team will undertake in their work on Fannie Mae's financial statements? Explain your answer in terms of auditing standards associated with these issues, such as those associated with proper engagement planning and risk assessment.

Reviewed By: Judy Beckman, University of Rhode Island

--- RELATED ARTICLES --- 
TITLE: Fannie's Dismissal of KPMG Shows Dwindling Choices Among Big Four 
REPORTER: Jonathan Weil 
PAGE: C1 ISSUE: Dec 23, 2004 
LINK: http://online.wsj.com/article/0,,SB110374574788607414,00.html 

Bob Jensen's threads on Fannie Mae are at http://www.trinity.edu/rjensen/caseans/000index.htm 


Question
What are hedge funds and why are they so controversial?

Answers

Definition from VAN --- http://www.hedgefund.com/abouthfs/what/what.htm 

A hedge fund can be classified as an alternative investment. Alternative investments are investments other than stocks and bonds. A U.S. "hedge fund" usually is a U.S. private investment partnership invested primarily in publicly traded securities or financial  derivatives. Because they are private investment partnerships, the SEC  limits U.S. hedge funds to 99 investors, at least 65 of whom must be "accredited." ("Accredited" investors often are defined as investors having a net worth of at least $1 million.) A relatively recent change in the law (section 3(c)7) allows certain funds to accept up to 500 "qualified purchasers." In order to be able to invest in such a fund, the investor must be an individual with at least $5 million in investments or an entity with at least $25 million in investments. The General Partner of the fund usually receives 20% of the profits, in addition to a fixed management fee, usually 1% of the assets under management. The majority of hedge funds employ some form of hedging -- whether shorting stocks, utilizing "puts," or other devices. 

Offshore hedge funds usually are mutual fund companies that are domiciled in tax havens, such as Bermuda, and that can utilize hedging techniques to reduce risk. They have no legal limits on numbers  of non-U.S. investors. Many accept U.S. investors, although usually only tax-exempt U.S. investors. For the  purposes of U.S. investors, these funds are subject to the same legal guidelines as U.S.-based investment partnerships; i.e., 99 U.S. investors, etc. 

Hedge funds are as varied as the animals in the African jungle. Over the years, many investors have assumed that hedge funds were all like the famous Soros or Robertson funds - with high returns, but also  with a lot of volatility. In fact, only a small percentage of all hedge funds are "macro" funds of that type. Among the others, there are many that strive for very steady, better-than-market returns. VAN tracks 14 different styles of hedge funds, in addition to a number of sub-styles.

The Loophole:  Locked-up funds don't require oversight.  That means more risk for investors.
"Hedge Funds Find an Escape Hatch," Business Week, December 27, 2004, Page 51 --- 

Securities & Exchange Commission Chairman William H. Donaldson recently accomplished a major feat when he got the agency to pass a controversial rule forcing hedge fund advisers to register by 2006. Unfortunately, just weeks after the SEC announced the new rule on Dec. 2, many hedge fund managers have already figured out a simple way to bypass it.

The easy out is right on page 23 of the new SEC rule: Any fund that requires investors to commit their money for more than two years does not have to register with the SEC. The SEC created that escape hatch to benefit private-equity firms and venture capitalists, which typically make long-term investments and have been involved in few SEC enforcement actions. By contrast, hedge funds, some of which have recently been charged with defrauding investors, typically have allowed investors to remove their money at the end of every quarter. Now many are considering taking advantage of the loophole by locking up customers' money for years.

TROUBLING QUESTIONS 
Securities lawyers say phones are ringing off the hook with questions from hedge funds considering circumventing registration. Some firms have already held small seminars packed with hedge fund managers discussing the potential cost and hassle of registering. Analysts estimate there are over 7,000 hedge funds, with roughly $1 trillion in assets; many may be looking for an out. Lindi L. Beaudreault, an attorney at Washington-based law firm LeClair Ryan estimates that "one third of unregistered hedge fund advisers are seriously considering locking up their investors' money for two years" to avoid registering.

Hedge funds seeking to skirt SEC registration raises troubling questions given their recent track record. In the last five years, the SEC has authorized or brought 51 cases against hedge fund advisers for allegedly defrauding investors of over $1 billion. And some SEC officials are already conceding that the exemption could be problematic. "If we see a significant invasion of the rule, we'll have to rethink," says Paul F. Roye, director of the division of investment management at the SEC.

The SEC did anticipate that some hedge funds would try to take advantage of the loophole. It concluded that investors would have the smarts to steer clear of any fund trying to evade the rule. But it may be tough for investors to distinguish between funds that are lengthening their so-called lockup periods simply to avoid registering, versus those with legitimate reasons for a longer investment horizon, such as a strategy based on turning around troubled companies. Already, investors in 5% of hedge funds with more than $1 billion in assets, many of which had voluntarily registered before the rule was introduced, have agreed to funds' demands that they hand over their money for two years or more, according to Chicago-based researcher Hedge Fund Research Inc. Still, if hedge fund exceptions become the rule, Donaldson's coup might turn out to be a Pyrrhic victory.

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


"The Mutual Fund Trading Scandals," by Brian Carroll, Journal of Accountancy,  pp. 32-37 --- http://www.aicpa.org/pubs/jofa/dec2004/carroll.htm

EXECUTIVE SUMMARY
SINCE THE FIRST MAJOR MARKET-TIMING and late-trading scandal broke, a barrage of federal and state enforcement actions against funds has followed.

LATE-TRADING IS ILLEGAL UNDER FEDERAL securities laws and some state statutes. It occurs when a mutual fund or intermediary permits an investor to purchase fund shares after the day’s net asset value is calculated, as though the purchase order were placed earlier in the day.

THE SEC HAS ADOPTED A NEW RULE requiring a fund to disclose in its prospectus and statement of additional information its market-timing risks; policies and procedures adopted, if any, by the board of directors, aimed at deterring market-timing; and any arrangement that permits it.

THE SEC HAS PROPOSED A NEW RULE that generally would require all mutual fund trades to be placed by a “hard 4 p.m.” Eastern time deadline.

 IN CONTRAST TO LATE-TRADING, MARKET-TIMING is not illegal per se. Problems arise, however, when the timing of trades violates the disclosures in the prospectus. This can cause so many buys and sells that the costs escalate and the fund is disrupted, to the detriment of its long-term shareholders.

Brian Carroll, CPA, is special counsel with the U.S. Securities and Exchange Commission in Philadelphia. He also is an adjunct professor at Rutgers University School of Law in Camden, New Jersey.

The U.S. Securities and Exchange Commission disclaims responsibility for any private publication or statement of any commission employee or commissioner. This article expresses the author’s views and does not necessarily reflect those of the commission, the commissioners or other members of the staff.

Bob Jensen's threads on the mutual fund scandals are at http://www.trinity.edu/rjensen/fraudRotten.htm#MutualFunds

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


From 'Smart Stops on the Web', Journal of Accountancy, December 2004, Page 29 --- http://www.aicpa.org/pubs/jofa/dec2004/news_web.htm 

SMART STOPS ON THE WEB
 
MUTUAL FUND SITES

Back to Basics
mutualfunds.about.com
CPAs looking for a refresher course on mutual funds will find articles such as “Determining Your Mutual Fund’s ‘Cost Basis’” and “Avoiding Internet Investment Scams.” Users can sign up for a free 10-day online course on the basics of mutual fund investing or a mutual fund newsletter. Other resources include links to broker ratings of funds, financial calculators and glossaries.

The Fund Finder
www.mutualfundsnet.com
CPAs looking for investment information for their clients will want to bookmark this Web site. In addition to free mutual fund sponsor searches in categories such as socially responsible corporate and government mutual funds, users can find information about investment conferences and links to breaking industry news. CPA broker-dealers can add their resumes to the database or check job postings from listed companies.

For Fund Facts
www.mfea.com
Investment advisers looking to educate their clients on mutual fund options will find detailed information on topics including taxes and fund risk at this stop on the Web. Users can find explanations of the differences among mutual funds and a glossary of investment terms or search for funds, create model portfolios or use calculators for college, retirement and tax-savings plans.

The Kids and College section of this Web stop links to sites that offer investment resources for money-minded children, such as calculators to help them decide how much allowance to save for major purchases and a dictionary of basic investment terms.

Satisfy Your Need to Know
www.ici.org
Here visitors can find free statistics on money market mutual fund assets or reports on the latest industry developments, such as “SEC changes SRO Procedures for Filing Rule Changes.” Other sections include A Guide to Understanding Mutual Funds, Frequently Asked Questions and a news archive dating back to 1995.

Keep Track of the Market
www.123jump.com
Users can register for free to keep tabs on their mutual funds at this e-stop, which offers general business, current and archived earnings news, as well as QuoteStream to see how your picks measure up on the Nasdaq, NYSE and S&P 500 stock index. Visitors also can get two daily e-mail newsletters, Earnings Ticker and Ticker AM—Business News Update.

Bob Jensen's helpers for investors are at http://www.trinity.edu/rjensen/bookbob1.htm#Finance


How to Pass Price Risk Along to Uncle Sam
Agribusiness Lobby Reaps the Biggest Harvest in Washington DC

A farmer can sell his crop early at a high price, say, in a futures contract, and still collect a subsidy check after the harvest from the government if prices are down over all. The money is not tied to what the farmer actually received for his crop. The farmer does not even have to sell the crop to get the check, only prove that the market has dropped below a certain set rate.
"Big Farms Reap Two Harvests With Subsidies a Bumper Crop," by Timothy Egan, The New York Times, December 26, 2005 --- http://www.nytimes.com/2004/12/26/national/26farm.html?oref=login  

The roadside sign welcoming people into this state reads: "Nebraska, the Good Life." And for farmers closing out their books at the end of a year when they earned more money than at any time in the history of American agriculture, it certainly looks like happy days.

But at a time when big harvests and record farm income should mean that Champagne corks are popping across the prairie, the prosperity has brought with it the kind of nervousness seen in headlines like the one that ran in The Omaha World-Herald in early December: "Income boom has farmers on edge."

For despite the fact that farm income has doubled in two years, federal subsidies have also gone up nearly 40 percent over the same period - projected at $15.7 billion this year, and $130 billion over the last nine years. And that bounty is drawing fire from people who say that at this moment of farm prosperity, the nation's subsidy system has never made less sense.

Even those deeply steeped in the system acknowledge it seems counterintuitive. "I struggle with the same question: how the hell can you have such high government payments if farmers had such a great year?" said Keith Collins, the chief economist for the Agriculture Department.

The answer lies in the quirks of the federal farm subsidy system as well as in the way savvy farmers sell their crops. Mr. Collins said farmers use the peculiar world of agriculture market timing to get both high commodity prices and high subsidies.

"The biggest reason is with record crops, prices have fallen," he said. "And farmers are taking advantage of that."

A farmer can sell his crop early at a high price, say, in a futures contract, and still collect a subsidy check after the harvest from the government if prices are down over all. The money is not tied to what the farmer actually received for his crop. The farmer does not even have to sell the crop to get the check, only prove that the market has dropped below a certain set rate.

Continued in article

Bob Jensen's threads on futures contracts and other derivative financial instruments are at http://www.trinity.edu/rjensen/caseans/000index.htm 

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


A majority of financial executives (57 percent) say Sarbanes-Oxley (SOX) compliance was a good investment for stockholders, according to a report released this month by Oversight Systems, the 2004 Oversight Systems Financial Executive Report On Sarbanes-Oxley Compliance, a nationwide survey of 222 financial executives.
"Financial Execs Call SOX 'Good Investment'," SmartPros, December 22, 2004 --- http://www.smartpros.com/x46291.xml 

Ernst & Young's Chairman and CEO Jim Turley notes in a Wall Street Journal article that Section 404 of the US Sarbanes Oxley Act is a critical step in enhancing investor confidence. He adds that the law entails a major risk in its first year "that the opinions on internal controls provided by management and independent auditors may be misinterpreted by the market." But the bottom line is, "investors will derive significant benefits from the implementation of Section 404. And the markets, in turn, will benefit from the enhanced investor confidence."
E&Y Faculty Connection --- http://www.ey.com/global/content.nsf/International/Home

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


"College Textbook Prices Criticized," by Stuart Silverstein, Los Angeles Times, February 2, 2005 --- http://snipurl.com/textbookFeb_4 

A national student activist organization stepped up its criticism of college textbook publishers Tuesday, asserting that the industry imposed exorbitant wholesale price increases totaling 62% over the last decade on top-selling books. That amounts to more than double the nation's overall rise in consumer prices during the same period.

"Textbook prices are skyrocketing, and publishers continue to use gimmicks to inflate the price, making higher education less affordable," said Merriah Fairchild, a Sacramento-based higher education advocate. She worked with the national State Public Interest Research Groups organization in preparing a new report on textbook pricing released Tuesday.

The activist organization also complained that the textbook publishing industry charged U.S. students more than foreign students for the same texts. It found that the average textbook cost 17% more in the United States than it did in Britain. In all, it estimated that the average U.S. college student spent about $900 a year on textbooks, although industry officials put the figure at $625.

The college textbook industry called much of the report badly flawed, saying the findings were based on a small sampling of popular but costly textbooks that exaggerated the overall rise in prices to students. Industry officials also maintained that the price of textbooks had risen more slowly than college tuition and fees.

They also sought to shift some blame for costs onto college instructors and their faculty committees, saying that they were free to order less expensive texts for their students. Professors "are in control of that choice," said Bruce Hildebrand, executive director for higher education with the Assn. of American Publishers.

But Hildebrand also said that the student organization's estimated 17% gap in prices of texts sold in the U.S. compared with those in Britain "seems reasonable."

The United States "is the richest market in the world. You sell into what the market will handle. It's like Coca-Cola sold for less overseas," he said.

The report — titled "Ripoff 101: 2nd Edition" — is a follow-up to a smaller-scale study released a year ago. Like the previous version, it accused the industry of a variety of ploys to inflate textbook prices.

Among other things, it said publishers released unnecessary new editions of texts every few years as a way to push up prices and make less expensive used books obsolete.

The activist organization also repeated its contention that publishers often packaged textbooks with unneeded instructional materials such as CD-ROMs and workbooks to drive up the price.

Continued in the article

The Ripoff 101 download is at http://calpirg.org/reports/textbookripoff.pdf 

Bob Jensen's threads on publisher frauds are at
 http://www.trinity.edu/rjensen/FraudReporting.htm#ScholarlyJournals 


Sarbanes-Oxley Reference Articles --- http://www.fmsinc.org/cms/?pid=3253

Sarbanes-Oxley and Investor Resource Guides

These guides were jointly developed by Deloitte & Touche LLP, Ernst & Young LLP, KPMG LLP and PricewaterhouseCoopers LLP around a shared commitment to investor education.

Forwarded by Dennis Beresford on December 22, 2004

Denny

-------- Original Message --------
Subject: S-OX Internal Control Investor Resource Guides
Date: Tue, 21 Dec 2004 17:45:05 -0500
From: Deloitte, Ernst & Young, KPMG, PricewaterhouseCoopers <investorinfo@s-oxinternalcontrolinfo.com>
To: <investorinfo@s-oxinternalcontrolinfo.com>


The Sarbanes-Oxley Act of 2002 (the Act) rewrote the rules for corporate governance, internal control, and financial reporting. It aims to restore public confidence and protect the public interest by improving the integrity of financial reporting – the foundation on which the U.S. capital markets system is built and thrives. Section 404 of the Act focuses heavily on the critical role of internal control over financial reporting, re-emphasizing the importance of ethical conduct and reliable information in the preparation of financial information reported to investors.
 
In the near future, investors will see new reports from management and auditors about whether adequate internal control over financial reporting is in place.  This information is important to investors because good internal control over financial reporting is one of the most effective deterrents to fraud and a key factor in preventing financial misstatements.  For the marketplace to fully benefit from this new reporting, market participants must be well informed about the new internal control reporting and the issues to consider in interpreting them.  The end benefit of this new reporting is greater transparency and flow of information, ultimately resulting in enhanced investor confidence and more effective allocation of capital in the marketplace.
 
To assist investors - individual and institutional, small and large - in understanding the new internal control reporting, Deloitte & Touche LLP, Ernst & Young LLP, KPMG LLP, and PricewaterhouseCoopers LLP have developed two resource guides to address many of the questions that may arise.
 
Designed as a broad overview of Section 404 of the Act, this brochure explains the background and rationale for the new reports, provides a brief description of what the new reports will include, and explains the meaning of control deficiencies, management’s report and the independent auditor’s opinion.

More detailed and in depth, this publication, in question and answer format, is designed for investors and other market intermediaries including brokers, analysts and rating agencies interested in additional information on specific topics related to internal control reporting, material weaknesses, and the potential marketplace implications of the new reporting.

We hope you find these publications timely and helpful.  We strongly believe that the marketplace can fully benefit from these reforms.  We believe our role in restoring public trust includes helping investors and other market participants stay well-informed about the meaning and implications of Section 404 of the Sarbanes-Oxley Act.

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


Parmalat's Tonna Reaches Out to the Public
Fausto Tonna, the self-confessed mastermind of the accounting shenanigans that crippled Parmalat, is attempting a new role: Mr. Nice Guy.

"After Scandal, Mr. Tonna Reaches Out to Public; Keeping His Cool on TV," by Alessandra Galloni, The Wall Street Journal, December 27, 2004, Page A1 --- http://online.wsj.com/article/0,,SB110410023880909615,00.html?mod=home%5Fpage%5Fone%5Fus  

Fausto Tonna, self-confessed mastermind of the accounting shenanigans that crippled Parmalat SpA, admits he has a problem with anger management. During a perp walk earlier this year, he turned to a bunch of journalists and shouted: "I wish you and your families a slow and painful death."

Recently sprung from nine months in detention, Mr. Tonna, who once smashed a glass door to bits, is attempting a new role: Mr. Nice Guy.

Between bites of tortelli at a trattoria near his home in this northern Italian village, he oozes charm as he pours two glasses of sparkling wine and seeks some forgiveness for his role in Europe's biggest-ever fraud. "It makes me vomit," the former chief financial officer says, admitting to a decade of cooking the books at the Italian dairy giant. "But I don't want to go down in history as the culprit."

Italian prosecutors have fingered Mr. Tonna, 53 years old, as one of the two chief villains in a nearly $19 billion scam that bankrupted Parmalat a year ago, alleging that he and founder Calisto Tanzi engineered fake deals that fed the fraud. They have requested Mr. Tonna's indictment on charges of market manipulation and are investigating him for false accounting and fraud.

Like many an embattled executive, he is going public with his story. But in sharp contrast to Martha Stewart, Kenneth Lay of Enron Corp. and other white-collar suspects who fought to the bitter end, Mr. Tonna is baldly admitting guilt, with the caveat that he worked for an even bigger alleged crook.

"The most disgusting part of my job was finding justifications for fixing the accounts," the barrel-chested finance man confides in his husky voice. In early 2003, when Mr. Tanzi needed more than $5 million to buy out a niece's 2% stake in Parmalat's holding company, "he told me to transfer the money out of the company and into a bank account and I did," Mr. Tonna says, adding that he then had to cover up the deal.

Mr. Tonna's strategy of mea culpas has a certain twisted logic in Italy. He doesn't aim to put prosecutors off the scent but to win pardon from the public, so he can return to a semblance of normal life while his case crawls through Italy's convoluted justice system. In Italy, suspects' public comments aren't necessarily used against them in a court of law. Mr. Tonna has a potentially rich vein of sympathy to tap, as Italians have grown disenchanted with the courts. Justice moves slowly: A first trial in the Parmalat case isn't likely until late 2005, and a lengthy appeals process means definitive verdicts will take years.

The disillusionment is a turnabout from the early 1990s, when the "Clean Hands" probes made heroes of prosecutors who uncovered vast corruption among politicians and businessmen. Many of those investigations fizzled, while several trials are dragging on. One suspect from the time -- Prime Minister Silvio Berlusconi -- has spent his political career blasting Italian prosecutors. A verdict earlier this month cleared Mr. Berlusconi of the final charges against him, partly because the statute of limitations expired on a bribery charge, further fueling popular misgivings about the justice system.

Continued in article

The external auditor, Grant Thornton, threads on this and other scandals can be found at http://www.trinity.edu/rjensen/fraud001.htm#GrantThornton 


Free International Financial Reporting Standards (IFRS) Copies

January 5, 2005 message from Paul Pacter

I posted a news story on www.iasplus.com  yesterday about new full text postings by the EC.

Plus I put a permanent link on my website to the EC postings of IASs.

I hope this email goes thru.

Paul


"Defendants Operating a College Financial Aid Scam to Pay $1,433,000 in Consumer Redress to Settle FTC Charges," Federal Trade Commission, January 12, 2005 --- http://www.ftc.gov/opa/2005/01/collegeadvantage.htm 

Individual Defendants Must Post a Million Dollar Bond

Four defendants operating a college financial aid scam have agreed to a multimillion dollar judgment with the Federal Trade Commission. The Commission filed its action as part of the Southwest Netforce Sweep announced in May 2003, alleging that the defendants misrepresented several claims made to consumers regarding their ability to obtain 100 percent of all funds necessary for college. Under the terms of separate settlements, the defendants must pay consumer redress totaling $1,433,000. Further, the individual defendants must post a $1 million bond before engaging in the advertising, promotion, or sale of college financial aid assistance programs.

Today’s settlements are with: The College Advantage. Inc., doing business as College Funding Center; Alan E. Baron and relief defendant Donna S. Baron (the Baron defendants); C Funding Group, LLC, d/b/a College Funding Group; and Edward F. Jacob and relief defendant Claudia L. Jacobs (the Jacobs defendants).

The FTC alleged that, using seminars and sophisticated Web sites, the defendants promoted and marketed a college financial aid assistance program promising that, for $1,000-$2,000, they would get 100 percent of the funding necessary for students to attend college. The complaint alleged that the defendants violated the FTC Act by misrepresenting that they would: (1) secure 100 percent of the funding necessary to attend college; (2) reduce the out-of-pocket expenses to attend college; and (3) fully refund consumers’ money if they failed to secure 100 percent of the funding necessary to attend college.

The settlement with the Jacobs defendants announced today requires them to pay $1,400,000 in consumer redress. The settlement with the Baron defendants requires them to pay $33,000 in redress. In addition, the defendants to post a $1 million performance bond prior to any future involvement in the promotion and marketing of college financial aid assistance programs. Both final judgments contain a suspended judgment of $15,509,564 and an avalanche clause that would reinstate the entire judgment if it is found that the defendants made material misrepresentations in their financial statements.

Finally, the settlements contain various recordkeeping requirements to assist the FTC in monitoring the defendants’ compliance.


6 January 2005: FEI top 10 financial reporting issues for 2005
Financial Executives International has compiled a list of the Top 10 Financial Reporting Challenges for 2005. While the list is written primarily in a US reporting context, nearly all of the challenges on the list relate to IASB projects as well:
  • Stock Options (SFAS 123 and IFRS 2).
  • Internal Controls.
  • Revenue recognition (a joint IASB-FASB project).
  • Uncertain tax positions (FASB and IASB are working to converge their income tax standards).
  • Unremitted foreign earnings (FASB and IASB are working to converge their income tax standards).
  • Business Combinations (a joint IASB-FASB project).
  • Inventory costs (FASB has issued Statement 151 in late 2004 to converge with IAS 2).
  • Off-balance-sheet arrangements disclosures.
  • XBRL (an IFRS Taxonomy has been developed).
  • MD&A guidance (an IASB research project).


More Troubles for Deloitte & Touche

Question
What CPA auditing firm has the dubious honor of having been the auditor for the company that is now designated as the largest bankruptcy case in the history of the world?

Answer
Deloitte Touche Tomatsu

Deloitte faces a potential $2 billion legal claim over audits of Forest Re, an aviation reinsurer that failed after 2001's terror attacks.

"Deloitte Faces $2 Billion Claim Over Audits of Reinsurance Firm," by Mark Maremont, The Wall Street Journal, November 11, 2004, Page A1 --- http://online.wsj.com/article/0,,SB110012218459670519,00.html?mod=home_whats_news_us 

 

Adelphia had billions in losses since 2001 and underreported losses before that, according to an audited financial statement.  Examples of improper accounting included Adelphia's treatment of certain operating expenses as capital expenses, Ms. Wittman said. The company also didn't accurately record management fees and interest that flowed between the Adelphia and the Rigas-owned properties, she added.
Peter Grant (See below)

"Adelphia Reaudit Shows Big Losses In the Past 3 Years," by Peter Grant, The Wall Street Journal, December 23, 2004, Page A2 --- http://online.wsj.com/article/0,,SB110384016071508558,00.html?mod=home_whats_news_us 

Adelphia Communications Corp. posted billions of dollars in losses during the past three years and underreported losses before that, according to the cable company's first audited financial statement released since 2002.

Adelphia, which was forced into bankruptcy-court protection in 2002 because of an accounting and corporate-looting scandal, posted losses of $7.25 billion in 2002 and $6.17 billion in 2001, mostly due to asset write-offs, the new financial statement says. The company also reported a 2003 net loss of $839.9 million, or $3.31 a share, on revenue of $3.6 billion.

In addition, the company, based in Greenwood Village, Colo., said it failed to report $1.7 billion in losses in the years before 2001. All the figures were contained in the company's annual report for the year ended Dec. 31, 2003, filed yesterday with the Securities and Exchange Commission.

The financial statement is seen as an important step in the company's move toward selling itself or emerging from bankruptcy proceedings. To produce an audited financial statement for 2003, the company had to go back and clean up its books for several previous years.

Adelphia, the country's fifth-largest cable operator by subscribers, is selling itself in an auction that has attracted several potential buyers, including the country's top cable operators and private-equity firms. Adelphia founder John Rigas and his son, Timothy Rigas, the company's former chief financial officer, were convicted on numerous counts of criminal fraud and conspiracy in the summer and are awaiting sentencing.

The filing totals more than 800 pages. The company hadn't filed annual reports for 2001 and 2002 because its records were found to be in terrible shape after the scandal erupted in the spring of 2002.

"We had to crawl through such a mess to try to restore this company to order," Vanessa Wittman, Adelphia's chief financial officer as part of its new management, said yesterday. She said that reconstructing Adelphia's books took a team of accountants tens of thousands of hours.

Ms. Wittman said the accounting team spent a long time determining an opening balance for 2001. To do that, the team had to wade through a number of fraudulent accounting methods and dealings between Adelphia and companies owned independently by the Rigas family. "The cumulative losses for the prior periods were $1.7 billion worse than reported," Ms. Wittman said.

Examples of improper accounting included Adelphia's treatment of certain operating expenses as capital expenses, Ms. Wittman said. The company also didn't accurately record management fees and interest that flowed between the Adelphia and the Rigas-owned properties, she added.

"Adelphia's 'Accounting Magic' Fooled Auditors, Witness Says<" by Christine Nuzum, The Wall Street Journal, May 5, 2004 --- http://online.wsj.com/article/0,,SB108369959478101710,00.html?mod=technology_main_whats_news

Adelphia Communications Corp. revealed its real results and its publicly reported inflated numbers in the books given to many employees, including founder John Rigas and two of his sons, a former executive testified.

But these financial statements, detailing actual numbers and phony ones dating back to 1997, weren't disclosed to the company's auditors, Deloitte & Touche, said former Vice President of Finance James Brown in his second day on the stand. Former Chief Financial Officer Timothy Rigas supported the system to keep employees aware of the company's real performance, Mr. Brown testified.

For example, one internal document showed that while Adelphia's operating cash flow was $177 million for the quarter ended in September 1997, its publicly reported operating cash flow was $228 million, Mr. Brown said.

Mr. Brown has pleaded guilty in the case and is testifying in hopes of receiving a reduced sentence.

John Rigas, his sons Timothy Rigas and former Executive Vice President Michael Rigas, and former Assistant Treasurer Michael Mulcahey are on trial here on charges of conspiracy and fraud. Michael Rigas was back in court yesterday, one day after court was canceled due to a medical issue that sent him to the hospital over the weekend. People close to the case said the problem was minor.

Mr. Brown said he devised various schemes to inflate Adelphia's publicly reported financial measures. Company executives were afraid that if Adelphia's true performance was revealed, the company would be found in default of credit agreements, he said. "I used the term 'accounting magic,' " Mr. Brown said.

In March 2001, phony documents dated 1999 and 2000 were created "to fool the auditors into believing that they were real economic transactions," he testified.

Mr. Brown discussed the details of how to inflate Adelphia's financial measures with Timothy Rigas more than the other defendants, but John Rigas and Michael Rigas also knew that the company's public filings didn't represent its real performance, he testified. John Rigas occasionally showed discomfort with the inflation, but did nothing to stop it, Mr. Brown said.

Mr. Brown testified he used to regularly tell John Rigas Adelphia's real results and how they compared with those of other cable companies. "On one occasion John told me, 'We need to get away from this accounting magic,' " he recalled. Mr. Brown added that he understood that to mean that Adelphia needed to boost its operations so that at some point in the future, the inflation could stop.

In another discussion about inflated numbers in early 2001, John Rigas "told me he felt sorry for Tim Rigas and me because the operating results were putting so much pressure on us ... but he said, 'You have to do what you have to do,' " Mr. Brown testified. "He also said we can't afford to have a default." Mr. Brown said he took that to mean that reporting inflated numbers was preferable to defaulting.

Creditor claims against Adelphia Communications Corp. total a staggering $3 trillion, or close to 40 percent of the national debt, Dow Jones Newswires reported. But many of the claims pending against the nation's fifth-largest cable company could turn out to be duplicates, and may be more like $18.6 billion

"Adelphia's Complex Bankruptcy: Claims Total $3 Trillion," AccounntingWeb, October 13, 2004 --- http://www.accountingweb.com/cgi-bin/item.cgi?id=99904 

It is what some are calling the most complicated bankruptcy case in history.

Creditor claims against Adelphia Communications Corp. total a staggering $3 trillion, or close to 40 percent of the national debt, Dow Jones Newswires reported. But many of the claims pending against the nation's fifth-largest cable company could turn out to be duplicates, and may be more like $18.6 billion when all is said and done.

Regardless, the company's structure is extremely complex and more than 60 accountants are wading through mountains of documents trying to reconcile claims against the Colorado company's 243 separate entities.

Company spokesman Paul Jacobson told Dow Jones that Adelphia's case is "arguably the most complex bankruptcy in U.S. business. It is a strange animal."

"A person is only entitled to be paid once, but trying to sort that out turns into an accounting nightmare," Paul Rubner, a Denver bankruptcy lawyer, told Dow Jones. He said creditors must correctly identify the entity that owes them.

"The good news is that you have to be specific about where you file it," Rubner said. "The bad news is that if the client is unsure, the lawyer is apt to file it in every possible case."

With more than 5 million subscribers, the cable company filed for bankruptcy in 2002 and expects to restate its financial statements from 1999 through 2001.

The company's founder John Rigas, and his son Timothy were convicted this year of conspiracy, bank fraud and securities fraud for looting the company and lying about its finances before the bankruptcy, Dow Jones reported.

Bob Jensen's threads on woes at Deloitte & Touche are at http://www.trinity.edu/rjensen/fraud001.htm#Deloitte 


Accounting Standards are Not Neutral (i.e., they change management decisions)

Question
How do you value a capped option?

Answer
Beats me, but the Black Scholes model component for time value must be modified.  But then the BS model doesn't work too well anyway since employees tend to value uncapped options much lower than BS model estimates (mostly out of fear that their options will tank).  They will accordingly reduce their estimates of value even lower if the options have caps.  I leave it up to you to explain to students why options with seven year expiration dates have lower value than traditional ten year dates, which in turn will result in higher corporate earnings per share if seven year expirations are used.  Hint:  It all has to do with that time value component of option value.

"Stock-Option Plans Get Revised to Meet New Rule," by Linlling Wei, The Wall Street Journal, December 30, 2004, Page C3 --- http://online.wsj.com/article/0,,SB110435344663812226,00.html?mod=todays_us_money_and_investing 

Companies are giving their stock-option plans makeovers.

In preparation for an accounting mandate that they treat employee stock options as an expense, companies are slashing option grants, replacing garden-variety options with various forms of stock compensation or tweaking the features of standard options.

"Most companies are looking at 'what are the alternatives?' " said Judy Thorp, national partner in charge of the compensation and benefits practice at KPMG.

One move under consideration, pay specialists say, is to cap the potential gain an employee or an executive can get from cashing in options. Tech Data Corp., for instance, already has won shareholder approval to issue such "maximum-value" stock options. Applera Corp. recently asked shareholders to vote on a similar proposal. Officials at both companies weren't available for comment.

A cap can make options less costly to companies than traditional options. It also "eliminates a concern of some investors that the open-ended nature of a traditional option could result in windfall gains for employees or executives," said Carl Weinberg, a compensation expert in the human-resources practice at PricewaterhouseCoopers.

Stock options give recipients the right to buy their companies' shares at a fixed price within a certain period. They pay off only if the stock price rises, unlike stock grants that companies have long had to count as expenses. Employees, compensation experts say, tend to exercise their options well before the rights expire, which typically occurs 10 years after the grant date.

Stock options grew in popularity during the 1990s. About 14 million American workers -- or 13% of the work force in the private sector -- hold options, according to professors at Rutgers University and Harvard University.

Under the new Financial Accounting Standards Board rule, companies will have to deduct the value of stock options from profits, beginning in mid-2005. The options are valued when they are issued, and companies spread the cost out over the vesting period. Technology companies -- heavy issuers of options -- could continue to lobby Congress to derail the rule, but analysts see little chance of congressional intervention.

Some companies, including Exxon Mobil Corp. and insurer Progressive Corp., have stopped granting stock options altogether. Instead, they make grants of restricted stock, or shares that recipients can't sell for a set period. Because they provide a more certain payoff, companies usually can dole out fewer such shares. It is also easier for companies to value these shares.

Other companies, like SBC Communications Inc., are turning to stock grants that are paid out only when specific financial or operational targets are met. Shareholders favor such "performance shares" as a way to align compensation more closely with investors' interests. Microsoft Corp. has decided to give its top 600 managers shares tied to the company's performance.

Shareholders of Intel Corp., meanwhile, have approved a new option plan that, among other changes, requires employees to exercise options in seven years instead of 10. At aluminum company Alcoa Inc., new stock options will have a six-year lifespan instead of 10 years. Options with shorter lives have a lower value.

Bob Jensen's threads on accounting for employee stock options are at http://www.trinity.edu/rjensen/theory/sfas123/jensen01.htm 

 


Audit Anxiety

January 19, 2005 article from David R. Fordham [fordhadr@JMU.EDU

Bob, in the four months that I was in Belgium, I was astounded at the unbelievable level of extreme sensationalism flaunted by the International Herald Tribune in its headlines and so-called “news reporting”. I came to scorn the IHT’s disguise of blatant opinion and biased analysis as news stories. I was sorely dismayed that there wasn’t a more factual-oriented reporting medium widely available in English.

That said, however, I now must quickly and clearly add that the truthfully-labeled opinions, commentary, and editorial content of the paper, as so eloquently exemplified in the article you distributed, were responsible for my remaining a faithful subscriber and reader. When properly identified as such, their editorial content and interest-stories seem (to my judgment and way of thinking) to be right on the mark, and always of high quality, up-to-date, and enlightening.

The article in your post is a case in point. The anecdotal attitude expressed in the article echoes a lot of what I hear from audit practitioners these days.

It appears that as a profession, auditors are still doing a pitiful job of managing the expectations gap. If a client company is unprepared for an audit, it doesn’t matter whether it is the company’s fault (for not being prepared or being familiar with its legal requirements) or the auditor’s fault (for not communicating the company’s new obligations, as the “paid expert” in those matters). All that matters is that there is a gap between the company and the auditor.

As professionals, it is probably incumbent upon auditors to go more than halfway in closing that gap. As it is, auditors (like many professionals: marketers, attorneys, politicians, intelligence operatives, military leaders, corporate managers, etc.), even the sincere and ethical ones, have become so engrossed in the “technical art of doing the job well” that they’ve lost sight of their roles (plural!) in society. One of those roles (of ANY profession!) is educating their clients, to improve life for everyone.

(Accounting professors, in general, for all their shortcomings, seem to have been relatively-less-infected by that malady, as we actively fight the AACSB’s efforts to add our occupation to that list.)

David R. Fordham – Opinione Ad Nauseum
PBGH Faculty Fellow
James Madison University

January 19, 2005 message from MILT COHEN [uncmlt@JUNO.COM

This article sparked a question in my mind and is addressed to those of you in the practice of public accounting.

It's been a number of years since I had my own practice. My question and curiosity centers on the gradual (if it's been gradual) introduction and increase in costs that each CPA and practioneer must afford in the form of Malpractice Insurance/Errors & Omission Insurance Premiums, Continuing Education courses, Compliance Expenses such as Oversight Review, (and now) Sarbanes-Oxley (I saw where some wag is calling it SOX) Education and similar/related expenses.

I know that costs to maintain computers, employment costs, rent, phones, advertising (if any) have all spiraled upward over the past 20 years. But those other items I've listed must have crept into practice costs and I wondered how the small firm is able to absorb or to successfully pass along in the form of fee increases to clients who may care less what the CPA must afford.

Thanks, Sincerely

Milt Cohen 
Chatsworth, Ca.

January 19, 2005 reply from Paul Bjorklund [PaulBjorklund@AOL.COM

In answer to Milt's question,
 
in the mid-80s I was a sole practitioner offering tax, A&A, and consulting services.  Faced with shrinking margins, longer hours, A/R bad debts, etc., I decided to rethink and redesign my work in order to accomplish my own personal goals.  The ideal practice in my mind would have no employees or partners, all income and no expenses, 100% collectibility of charges, all assets and no liabilities, reasonable work hours and working conditions.  In the 20 years since then I have been able to come close to all those goals.  Some of the things I did:
 
1) Eliminated bad clients;
2) Eliminated all employees - only use casual labor when there is a big work load;
3) Computerized extensively;
4) Abandoned traditional tax and accounting services for forensic economics and accounting;
5) Quit making lease payments in high rent districts and moved to a home office;
6) Found a niche that bigger competitors can't enter and smaller competitors don't know how to do;
7) Dress code is very casual.
 
This is not for everybody.  Some of the drawbacks are:
 
1) Cannot sell my practice when I am ready to retire;
2) Cannot take extensive vacations;
3) Have to put on a jacket and tie for trials and depositions;
4) Work comes unexpectedly in waves.
 
To me, the trade-offs are worth it.  Isn't this a wonderful profession in that it offers so many alternative career opportunities?
 
Paul
__________________________
Paul Bjorklund, CPA
Bjorklund Consulting, Ltd.
Flagstaff, Arizona

SOX Turned Inside Out

"Rein in the Public Company Accounting Oversight Board: Guest Article," by Peter J. Wallison, AccountingWeb, January 31, 2005 --- http://www.accountingweb.com/cgi-bin/item.cgi?id=100443 

By Peter J. Wallison, resident fellow at the American Enterprise Institute - The Public Company Accounting Oversight Board is a not-for-profit corporation established by the Sarbanes-Oxley Act to regulate the business of auditing public companies. Although industry self-regulatory organizations are not unusual, this one has the extraordinary power to tax all public companies to support its operations. Its freedom from the ordinary mechanisms of accountability for quasi-governmental functions is already having an effect, shown in its rapidly growing budget. But that is only one of the costs that this agency will impose on the economy. Before these costs get completely out of hand, Congress should intervene and bring it under control.

In all of the commentary about the Sarbanes-Oxley Act, not much attention has focused on the act's creation of the Public Company Accounting Oversight Board (PCAOB). This entity has some truly unique and troubling features. Although it was established by congressional legislation, it is a District of Columbia not-for-profit corporation, not a government agency. It is supposed to be a self-regulatory organization for the auditing activities of the accounting industry, but it is not supported by the industry it regulates; instead, it was authorized by Congress to fund itself by levying fees on all public companies--essentially a tax on the economy as a whole. Finally, although it is supposed to regulate the business of auditing public companies, no more than two of its five members--who must serve full-time--can have had backgrounds as accountants or auditors. This turns the whole concept of a self-regulatory body on its head. The original idea (of New Deal origin) was that industries could best regulate themselves because the regulators are experts in the way the industry functions; the PCAOB, however, was designed so as to prevent control by experts in accounting or auditing. This apparent bias against the accounting profession--so that accountants were not even permitted to control their own so-called self-regulatory organization--is a direct result of the overheated atmosphere in which the Sarbanes-Oxley Act was legislated. Passed in the wake of the Enron and WorldCom scandals, the act reflected hostility and distrust of corporate managements and the accounting profession, and out of this grew the regulations of Nasdaq and the NYSE that required public companies to be governed by boards with majorities of "independent" directors. In boardrooms, the act has impaired the collegiality that once prevailed between directors and management, and may be impairing the management risk-taking that is an essential element of economic growth. But for the accounting profession, it has created a sense of adversity between accountants and their regulator. Important rules and standards, which will profoundly affect the cost of audits and how auditors deal with their clients, are being developed by an inexperienced board staff that, from all reports, is keeping practicing accountants and auditors--those who understand the costs and issues involved--at arm's length. This is a prescription for trouble that the business community will ignore to its regret.

Although Congress has in the past authorized the creation of nongovernmental organizations, such as the Municipal Securities Rulemaking Board (MSRB), to regulate particular sectors of the economy, these self-regulatory organizations (known as SROs) have always been selected from and financially supported by the industry they regulate. The PCAOB, however, is not funded by the accounting profession but by fees levied on over 8,400 public companies. This is a significant difference, which raises questions about both the constitutionality of this organization and the degree to which its power and reach can be controlled.

It is difficult to imagine, for example, that Congress could constitutionally delegate to a private company what is essentially the power to tax the entire economy in support of its regulatory activities. There may be room in constitutional theory for SROs--regulatory bodies composed of industry members and supported by an industry--but under what principle can Congress authorize private companies to exercise what seem to be governmental regulatory powers and to support themselves through a delegated power to tax? On a more technical level, the Securities and Exchange Commission (SEC) appoints the members of the PCAOB, and constitutional scholars may wonder how this could have complied with the appointments clause of the Constitution, which clearly vests "in the President alone" appointments of officers of the United States. To be sure, the Sarbanes-Oxley Act declares that the members of the board and their staff are not "officers of the United States," but it seems highly unlikely that Congress can avoid the appointments clause simply with a form of words, or by authorizing a private corporation to do what the government itself would otherwise do.

The constitutionality of the PCAOB is an important issue that is likely to reach the courts in conjunction with its first major enforcement action, but this issue of the Financial Services Outlook will primarily consider a narrower question--whether there are any effective checks on the growth of the PCAOB and the costs it will continue to impose on the economy. As outlined below, by permitting the PCAOB to fund itself by taxing all public companies, Congress has freed the organization from all controls that normally place necessary and practical limits on the activities of both explicit government agencies and SROs.

Unchecked Authority

It is an axiom of American government that the exercise of all governmental power is subject to control. At the highest level, of course, the executive, legislative, and judicial branches of the government are all bound in a constitutional web of checks and balances. In this structure, Congress controls the other branches through its power to appropriate funds for their operations. Because the PCAOB has the power to make and enforce its own regulations, to hold disciplinary proceedings, and to impose penalties, there is little doubt that it has the normal attributes of a government agency. Yet, because it is authorized to tax all public companies in order to support its operations, it is able to operate free of the normal constraints on government agencies.

To be sure, the Sarbanes-Oxley Act placed the PCAOB under the general oversight and control of the SEC, which has the authority to appoint the members of the board, to remove them "for cause," to approve the board's regulations and annual budget, and--significantly--to assign other responsibilities to the board. While on its face this degree of authority would appear significant, a fuller consideration of the sources of the board's independence and the SEC's institutional interests suggests that under the current arrangement real and sustained control is likely to be illusory.

Through the annual appropriations process, Congress balances agency requests for funds against other priorities, and thus exercises practical control over the scope of agency activities by limiting agency resources. In addition, congressional committees with jurisdiction over particular areas of government activity conduct annual reviews of agency operations and effectiveness, and these oversight functions also place practical limits on the scope of agency activities. No similar structures exist for the PCAOB. Since it does not rely on congressional appropriations for its funding, there is little regular oversight of the board through the appropriations process, and as a private company that operates as a kind of subsidiary of the SEC there is no occasion for Congress to review the board's activities through regular oversight hearings. In its two years of operations, the board seems to have had only one oversight hearing--in a House subcommittee in June 2004.

Moreover, unlike other SROs, the PCAOB is not subject to any control by the industry it regulates. Indeed, as noted above, Congress designed the PCAOB so that it would be insulated from influence by the accounting profession. When an industry SRO is composed of and funded by members of the industry, there is an informal mechanism of control: the regulated industry, with an interest in reducing unnecessary expenditures, keeps a close watch on how much its SRO spends, and this in turn places an informal restriction on the regulatory reach of the agency. The members of the industry who serve on the governing board of the SRO--generally in part-time roles--are constantly in touch with others in the industry and receive critical commentary and feedback about the quality of the SRO's work. These informal elements of control over an SRO are missing in the case of the PCAOB. A majority of its board may not by law be members of the accounting profession, and since the board serves full-time, its members are isolated from day-to-day contact with accountants and auditors. Finally, and perhaps most important, the PCAOB is not funded by the industry it regulates, so the accounting profession has no financial incentive to pay attention to the organization's spending.

Continued in the article

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


February 4, 2004 message from Dennis Beresford [dberesfo@TERRY.UGA.EDU

Food for Thought

In my spare time I have been reading the daily transcripts of the trial now taking place in New York City of former WorldCom CEO Bernie Ebbers. There have been regular reports of the trial in the Wall Street Journal, New York Times, Washington Post and elsewhere. However, reading the actual testimony is quite interesting - not just the things that reporters choose to highlight in their brief, summary coverage.

On Wednesday, one of the witnesses was Troy Normand. He was a manager in the corporate reporting department and is one of five individuals who have pleaded guilty and now are testifying in hopes of receiving no prison time when they are ultimately sentenced. Normand received an accounting degree from LSU in 1994 and became a CPA in 1996. He joined WorldCom in 1997 and worked there until he was terminated in 2002.

I've pasted below a few pages of the direct examination of Normand by the prosecutor. It is gripping to see how he realized immediately that he was being asked to do something wrong but didn't have the courage or judgment to do the right thing then. I am sharing these words with my MAcc students on Monday as something for them to think about if, and I pray not, they are ever faced with similar circumstances.

Denny Beresford

7 Q. Had you been asked to make an entry of this size before?

8 A. No.

9 Q. What happened after you initially refused to make the

10 entry?

11 A. I told my supervisor I was considering resigning.

12 Q. Who did you talk to?

13 A. Buford Yates.

14 Q. What did he say when you told him that?

15 A. Actually, I told him in addition I wanted to speak to Scott

16 Sullivan, and he told me to go see David Myers.

17 Q. Mr. Normand, why were you considering resigning after you

18 were asked to make this entry?

19 A. Because of the size, and I just didn't think it was right.

20 Q. Did you go talk to David Myers?

21 A. Yes, I did.

22 Q. What did you say to him?

23 A. I told David the same and asked him to set up a meeting

24 with Scott Sullivan if possible.

25 Q. Now, prior to this time, had you requested a meeting with

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1 Scott Sullivan?

2 A. No, I had not.

3 Q. After this time, did you ever request a meeting with Scott

4 Sullivan again?

5 A. No.

6 Q. What happened next?

7 A. Shortly thereafter, David Myers came back to me and told me

8 that Scott was willing to talk to -- was ready to talk to us.

9 Q. Did you have a meeting?

10 A. Yes.

11 Q. Approximately when during the closing process did this

12 meeting take place?

13 A. It was very late in the close, right before the earnings

14 release.

15 Q. Where did the meeting occur?

16 A. In Scott Sullivan's office.

17 Q. Was anyone else present?

18 A. Yes.

19 Q. Who?

20 A. David Myers, Betty Vinson, Scott Sullivan and myself.

21 Q. Mr. Normand, if you could just describe for the jury how

22 the meeting started and what was said during the meeting?

23 A. I can't recall exactly who initiated the discussion, but

24 right away Scott Sullivan acknowledged that he was aware we had

25 problems with the entries, David Myers had informed him, and we

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1 were considering resigning.

2 He said that he respected our concern but that

3 nothing -- we weren't being asked to do anything that he

4 believed was wrong. He mentioned that -- he acknowledged that

5 the company had lost focus quite a bit due to the preparations

6 for the Sprint merger, and that he was putting plans in place

7 and projects in place to try to determine where the problems

8 were, why the costs were so high.

9 He did say he believed that the initial statements

10 that we produced, that the line costs in those statements could

11 not have been as high as they were, that he believes something

12 was wrong and there was no way that the costs were that high.

13 I informed him that I didn't believe the entry we were

14 being asked to do was right, that I was scared, and I didn't

15 want to put myself in a position of going to jail for him or

16 the company. He responded that he didn't believe anything was

17 wrong, nobody was going to be going to jail, but that if it

18 later was found to be wrong, that he would be the person going

19 to jail, not me.

20 He asked that I stay, don't jump off the plane, let

21 him land it softly, that's basically how he put it. And

22 mentioned that he had a discussion with Bernie Ebbers asking

23 Bernie to reduce projections going forward and that Bernie had

24 refused.

25 Q. Mr. Normand, you said that Mr. Sullivan said something

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1 about don't jump out of the plane.

2 What did you understand him to mean when he said that?

3 A. Not to quit.

4 Q. During this meeting, did Mr. Sullivan say anything about

5 whether you would be asked to make entries like this in the

6 future?

7 A. Yes, he made a comment that from that point going forward

8 we wouldn't be asked to record any entries, high-level late

9 adjustments, that the numbers would be the numbers.

10 Q. What did you understand that to be mean, the numbers would

11 be the numbers?

12 A. That after the preliminary statements were issued, with the

13 exception of any normal transaction, valid transaction, we

14 wouldn't be asked to be recording any more late entries.

15 Q. I believe you testified that Mr. Sullivan said something

16 about the line cost numbers not being accurate. Did he ask you

17 to conduct any analysis to determine whether the line cost

18 numbers were accurate?

19 A. No, he did not.

20 Q. Did anyone ever ask you to do that?

21 A. No.

22 Q. Did you ever conduct any such analysis?

23 A. No, I didn't.

24 Q. During this meeting, did Mr. Sullivan ever provide any

25 accounting justification for the entry you were asked to make?

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1 A. No, he did not.

2 Q. Did anything else happen during the meeting?

3 A. I don't recall anything else.

4 Q. How did you feel after this meeting?

5 A. Not much better actually. I left his office not convinced

6 in any way that what we were asked to do was right. However, I

7 did question myself to some degree after talking with him

8 wondering whether was I making something more out of what was

9 really there.

Bob Jensen's threads on the Worldcom scandal are at http://www.trinity.edu/rjensen/FraudEnron.htm#WorldcomFraud 


Bob Jensen's threads on Academics Versus the Accounting Profession (including the first tee shot by Denny Beresford) are at http://www.trinity.edu/rjensen//theory/00overview/theory01.htm#AcademicsVersusProfession 





 


Other Links
Main Document on the accounting, finance, and business scandals --- http://www.trinity.edu/rjensen/Fraud.htm 

Bob Jensen's threads on professionalism and independence are at  file:///C:/Documents%20and%20Settings/dbowling/Local%20Settings/Temporary%20Internet%20Files/OLK36/FraudUpdates.htm#Professionalism 

Bob Jensen's threads on pro forma frauds are at http://www.trinity.edu/rjensen//theory/00overview/theory01.htm#ProForma 

Bob Jensen's threads on ethics and accounting education are at 
http://www.trinity.edu/rjensen/FraudProposedReforms.htm#AccountingEducation

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

Incompetent and Corrupt Audits are Routine ---
http://www.trinity.edu/rjensen/FraudConclusion.htm#IncompetentAudits

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

Future of Auditing --- http://www.trinity.edu/rjensen/FraudConclusion.htm#FutureOfAuditing 

 

 


 

The Consumer Fraud Portion of this Document Was Moved to http://www.trinity.edu/rjensen/FraudReporting.htm 

 

Bob Jensen's home page is at http://www.trinity.edu/rjensen/