Updates on April 12,
Bob Jensen at Trinity University
Bob Jensen's main document on the Enron scandal and other accounting frauds is at http://www.trinity.edu/rjensen/fraud.htm
Loss of Reputation is a Kiss of Death
for a Public Accounting Firm: An Empirical Study
Andersen Audits Increased Clients' Cost of Capital Relative to Clients of Other Auditing Firms
Especially note the graph after October 1991!
"The Demise of Arthur Andersen," by Clifford F. Thies, Ludwig Von Mises Institute, April 12, 2002 --- http://www.mises.org/fullstory.asp?control=932&FS=The+Demise+of+Arthur+Andersen
From Yahoo.com, Andrew and I downloaded the daily adjusted closing prices of the stocks of these companies (the adjustment taking into account splits and dividends). I then constructed portfolios based on an equal dollar investment in the stocks of each of the companies and tracked the performance of the two portfolios from August 1, 2001, to March 1, 2002. Indexes of the values of these portfolios are juxtaposed in Figure 1.
From August 1, 2001, to November 30, 2001, the values of the two portfolios are very highly correlated. In particular, the values of the two portfolios fell following the September 11 terrorist attack on our country and then quickly recovered. You would expect a very high correlation in the values of truly matched portfolios. Then, two deviations stand out.
In early December 2001, a wedge temporarily opened up between the values of the two portfolios. This followed the SEC subpoena. Then, in early February, a second and persistent wedge opened. This followed the news of the coming DOJ indictment. It appears that an Andersen signature (relative to a "Final Four" signature) costs a company 6 percent of its market capitalization. No wonder corporate clients--including several of the companies that were in the Andersen-audited portfolio Andrew and I constructed--are leaving Andersen.
Prior to the demise of Arthur Andersen, the Big 5 firms seemed to have a "lock" on reputation. It is possible that these firms may have felt free to trade on their names in search of additional sources of revenue. If that is what happened at Andersen, it was a big mistake. In a free market, nobody has a lock on anything. Every day that you dont earn your reputation afresh by serving your customers well is a day you risk losing your reputation. And, in a service-oriented economy, losing your reputation is the kiss of death.
Nice Going Merrill Lynch: To Hell With the
Widows and Orphans
The pressures put on the Merrill Lynch internet group to appease both investment bankers and clients led the group to ignore the bottom two categories of the five-point rating system (“reduce” and “sell”) and to use only the remaining ratings (“buy”, “accumulate” and “neutral”). The absence of clear guidance from Merrill Lynch management on how to resolve the conflicts created by these pressures led respondent Henry Blodget, the head of the internet group, in a moment of candor, to threaten to “start calling the stocks (stocks, not companies)... like we see them, no matter what the ancillary business consequences are."
Chief of the Investment Protection Bureau of the New York State Department of Law and am of counsel to Eliot Spitzer, Attorney General of the State of New York before the Supreme Court of the State of New York, April 2002
(Dan Gode from NYU sent me this Merrill Lynch Indictment as an email attachment.)
Bob Jensen's similar "Go to Hells" from Investment Bankers are listed at http://www.trinity.edu/rjensen/fraud.htm#Cleland
Bob Jensen's April 12, 2002 updates on the Enron/Andersen scandals are at http://www.trinity.edu/rjensen/fraud041202.htm
April 3, 2002 message from Dennis Beresford [dberesfo@TERRY.UGA.EDU]
One of the things that I find most fascinating about the Enron/Andersen saga is how much inside information is being made public (thanks to our electronic age). Yesterday the House Energy and Commerce Committee released a series of internal Andersen memos showing the dialogue between the executive office accounting experts and the Houston office client service people. While I haven't had a chance to read all 94 pages yet, the memos are reported to show that the executive office experts raised significant questions about Enron's accounting. But the Houston people were able to ignore that advice because Andersen's internal policies required the engagement people to consult but not necessarily to follow the advice they received. As far as I know, all other major accounting firms would require that consultation advice be followed.
You can view and download the 94 pages at: http://energycommerce.house.gov/107/news/04022002_527.htm#docs
April 8 Reply from Kobelsky, Kevin [kobelsky@MARSHALL.USC.EDU]
Thank you for I'm not sure how far you got through the material, but to help others find their way, I suggest the most salient pages explaining how the SPEs work and the decisions that were made be read in the following order: 1. Enron transaction by Bass 2/1/00 (p.4 of all 95 pages if you download them all-about 2 megs) 2. Enron option by Bass 12/18/99 (p.1,2 of 95) 3. Enron by Bass 3/4/01 #3 "raptor" (p.11-12 of 95) which documents that $100 million in losses was hidden in one transaction. 4. Re: Enron Derivative Transaction by Bass 2/4/00 (p.7 of 95)
Please let me know of other items in there I've missed.
Kevin Kobelsky PhD CA*CISA
Assistant Professor Leventhal School of Accounting,
Marshall School of Business
University of Southern California Accounting Building 125 Los Angeles, CA 90089-0441
Voice: (213) 740-0657 Fax: (213) 747-2815
Jensen's SPE threads can be
From The Wall Street Journal Educators' Review on April 13, 2002
TITLE: 'Footnote Factor'
Looms Large This Year
REPORTER: Lynn Cowan and Karen Talley
DATE: Apr 08, 2002
SUMMARY: In the wake of the Enron fiasco, investors are paying more attention to the footnotes contained in the annual reports. Questions focus on the content of the footnotes and the importance of footnotes in interpreting the financial statement information.
1.) Describe three basic purposes of the financial statement footnotes. Why is this information important to users of financial statements?
2.) Refer to the quote by John Montgomery, "If there's 10 or 15 pages of footnotes, move on." Do you agree with Mr. Montomery? Contrast the quote by Mr. Montgomery with the SECs request for more detail in the financial statement footnotes. How do the financial statement preparers determine how much information to include in the financial statement footnotes?
3.) What is materiality? Discuss the concept of materiality as it relates to the content of financial statement footnotes.
Reviewed By: Kimberly Dunn, Florida Atlantic University
From The Wall Street Journal Accounting Educators' Review on April 4, 2002
TITLE: Enron's Auditors
Debated Partnership Losses;
Andersen Memos Show that the
Accountants Knew of Raptor
REPORTER: Jonathan Weil
DATE: Apr 03, 2002 PAGE: C1
TOPICS: Accounting For Investments, Advanced Financial Accounting, Auditing, Auditor Independence, Auditor/Client Disagreements, Financial Accounting
SUMMARY: The article describes the disagreement between Enron management and Arthur Andersen partners on an impairment test for Enron's investments in partnerships. The structure of the investments and a group impairment test had allowed Enron to avoid reporting losses. When Arthur Andersen finally expressed disapproval of the transactions, Enron was forced to report losses that shook investor confidence and ultimately brought Enron to bankruptcy.
1.) What is an impairment charge? How is it that an impairment loss on one asset may be offset against an impairment loss on another? When must an impairment charge be recorded for losses on long-term investments?
2.) What is the function served by Andersen's Professional Standards Group, or PSG? Why did that group disagree with the Andersen audit team's assessment of Enron's accounting for its investments in Partnerships called by the name "Raptor"?
3.) What was the ultimate result of Andersen's refusal to accept Enron's accounting for its investments?
4.) How do the auditing professional standards define independence? How do the Andersen memos indicate apparent problems with the firm's independence from this major client?
Reviewed By: Judy
Beckman, University of Rhode
Reviewed By: Benson Wier, Virginia Commonwealth University
Reviewed By: Kimberly Dunn, Florida Atlantic University
Members of the class action suit who are hoping to recoup lost retirement funds from now-defunct Enron Corporation amended their suit in Federal court Monday to include several investment banks, securities firms, and law firms. Led by lead plaintiff the University of California Board of Regents, thousands of Enron shareholders are participants in the suit. http://www.accountingweb.com/item/77539
A Bad Day for Baptists
Big Five firm Andersen has told Arizona state officials and others involved in the firm's settlement relating to the bankruptcy of the Baptist Foundation of Arizona that it will not be able to meet its obligation to pay $217 million for its role in the demise of the religious organization.
Andersen's lawyers said
that the firm's insurance
Services, is "unable to
approve or pay claims at
this time due to its
Sources familiar with the
issue indicate that the
financial position of the
carrier was compromised
because of Andersen's
failure to pay a $100
million premium. That missed
premium has made the
insurance carrier insolvent,
and raises questions on the
ability of Andersen to pay
ANY legal claims -
regardless of whether they
are Baptist Foundation
related or Enron related.
Course Supplements from the Enron Scandal
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Example news updates are listed below as of April 13, 2002
Andersen to admit it 'broke the law'... Guardian Unlimited Thu Apr 11 12:01:00 CDT 2002
KPMG, Andersen cease Central European merger talks... iWon Thu Apr 11 11:53:00 CDT 2002
Deloitte, Andersen To Merge Mexico Operations... Financial Express Thu Apr 11 11:18:00 CDT 2002
What the world needs is more bean counters... STUFF Thu Apr 11 10:33:00 CDT 2002
SEC to File Fraud Suit Against Xerox... Washington Post Thu Apr 11 09:27:00 CDT 2002
KPMG targets Andersen tie-up in Germany by Sep 30... iWon Thu Apr 11 08:19:00 CDT 2002
Qwest stock dives to record low... Rocky Mountain News Thu Apr 11 07:52:00 CDT 2002
Andersens British unit splits off to join competitor... Sun-Sentinel.com Thu Apr 11 06:59:00 CDT 2002
Report: Andersen Near Settlement with SEC... Ledger-Enquirer Thu Apr 11 06:55:00 CDT 2002
Report: Andersen Near Settlement with SEC... Macon Telegraph Thu Apr 11 06:51:00 CDT 2002
Bid to regulate energy trading gets nowhere... AccessAtlanta Thu Apr 11 06:41:00 CDT 2002
Andersens British unit splits... Sun-Sentinel.com Thu Apr 11 05:56:00 CDT 2002
Now Stagecoach axes Andersen... Evening Standard Thu Apr 11 05:34:00 CDT 2002
One More Reform From Enron... The Ledger Thu Apr 11 05:27:00 CDT 2002
Arthur Andersen says cant be held responsible for Enron bankruptcy... Ananova Thu Apr 11 05:17:00 CDT 2002
Tougher corporate responsibility measure introduced in House... Nando Times Thu Apr 11 05:10:00 CDT 2002
The accounting outrage you never hear about... MSN MoneyCentral Thu Apr 11 04:28:00 CDT 2002
Q1 earnings are impossible to parse... MSN MoneyCentral Thu Apr 11 04:28:00 CDT 2002
Suddenly, gold sits atop the mutual funds pile... MSN MoneyCentral Thu Apr 11 04:28:00 CDT 2002
Enron auditor will admit wrongdoing... Orlando Sentinel Thu Apr 11 04:01:00 CDT 2002
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From AccountingWeb on April 5 and April 11, 2002
A number of significant developments have emerged in the continuing Andersen story this week. Among the top headlines:
Aldo Cardoso Takes the Reins as Andersen CEO http://www.accountingweb.com/item/77115
Deloitte to Absorb Many Andersen Tax Professionals http://www.accountingweb.com/item/77139
Andersen Developments Around The World http://www.accountingweb.com/item/77056
Andersen Worldwide Network Continues to Disintegrate http://www.accountingweb.com/item/76833
Andersen Names Transition Team http://www.accountingweb.com/item/76501
Andersen Raises the Stakes with Audit Reforms http://www.accountingweb.com/item/76674
For a complete perspective of the entire Andersen story since the Enron saga broke, go to: http://www.accountingweb.com/item/76481
Andersen UK to Merge with Deloitte & Touche http://www.accountingweb.com/item/77680
Andersen Mulls Ground-Breaking LBO of Tax Practice http://www.accountingweb.com/item/77534
Insurance Companies Try to Stop Andersen Actions http://www.accountingweb.com/item/77297
Murat's Reply to Kevin's Reply on April 11, 2002
Your questions are excellent and as I read the internal memos of Andersen auditors either they did not dare to ask the question or were mired down in GAAP detail. As I recall, SPEs first started with securitizing receivables (mortgage notes) where an SPE simply buys the receivables and sells to outside investors in bundles then transfers the collections (purchase price) to the transferor. Thus, cash is coming in from an outside entity. In Enron's case there is no cash coming in from outside plus Fastow and company do not have capital to underwrite the risk. Enron is putting the assets their own stock [it would not have mattered if it was some other company's stock or Enron's cash! All Fastow is doing is giving Enron the wiggling room in accounting to get liabilities off balance sheet at a price. When no risk is transferred why is Enron getting into this deal is the question auditors should be asking rather than all the GAAP rules! In my opinion this is fraudulent.
Murat N. Tanju Professor of Accounting Phone # 205.934.8822 Fax # 205.975.4429
From: Kobelsky, Kevin [mailto:kobelsky@MARSHALL.USC.EDU]
Sent: Thursday, April 11, 2002 12:05 AM
Subject: Was Enron's treatment actually in compliance with GAAP? Clarifica tion re criterion for 'skin' in SPEs
Bob and learned colleagues,
On Bob's excellent web page, http://www.trinity.edu/rjensen/fraud021402.htm he comments, "In theory, the assets of the SPE should have "skin" in the sense that they are also assets that would appear on the consolidated balance sheet if the SPE was consolidated. For example, if General Electric decided to build a pipeline across Africa, GE could co-sign billions in debt/leases of an SPE. The SPE would then borrow the cash and commence to build the pipeline. The SPE's assets would be cash, land, pipes, etc. These have 'skin.' "
This is the only argument I've seen that specifically would indicate that Enron's SPEs were not in compliance with GAAP.
What is the source of this criterion? In the internal Andersen documents, even those written by Bass, this is not mentioned, and I wonder why none of them seemed to be aware of it.
I've been out of financial accounting for a while, but short of this criterion, other arguments that these transactions were not consistent with GAAP from a measurement point of view seem easily contestable (which I'd be glad to discuss), and changes the discussion to a debate about how 'clear' the notes are (e.g., I DO see mention of the $500 million in income impacts in note 16-a big red flag that Watkins mentions on p.7 #6 of her infamous memo to Lay).
Sure, Fastow was a related entity who was enriched to the tune of tens of millions of dollars, but despite the tone of the Board of Directors report, that's small potatoes from a measurement point of view, and a cost of this magnitude certainly would not justify bringing down Andersen, nor would such costs in themselves lead to the failure of Enron. Put another way, Enron would have collapsed just as quickly if an independent party had been doing the deals for huge fees because of the economic structure of the deals.
If the transaction were potentially in compliance with GAAP, we'd be in the unusual situation where the client complied with GAAP in a way that was materially misleading. If this is the case, based on an earlier thread re: the problems auditors have had in withholding opinions in these situations, maybe the profession at large is more culpable than Andersen.
So again, what is the source of this criterion and what basis do we have for holding Andersen to it?
Kevin Kobelsky PhD CA·CISA
Assistant Professor Leventhal School of Accounting,
Marshall School of Business
University of Southern California Accounting Building 125 Los Angeles, CA 90089-0441 Voice: (213) 740-0657 Fax: (213) 747-2815
Bob Jensen's SPE Threads are at http://www.trinity.edu/rjensen//theory/00overview/speOverview.htm
Some Interesting Items from Fortune, April 15, 2002
Revenue Games People (Like
Enron) Play Got energy
trading contracts?" FORTUNE,
By Carol J. Loomis,
April 15, 2002, pp. 190-191
The conclusion reads as follows:
A number of energy companies that FORTUNE checked with could cite no accounting standards in existence in the mid-1990s that validated gross reporting. Indeed, a partner in the national office of a Big Five accounting firm told FORTUNE that "this kind of reporting just sort of grew up."
Andrew Sunderman, a trading executive at Williams Cos., one of the few energy-related companies still reporting net, says he believes many of the companies that switched to gross reporting got "fascinated with growth in the revenue line." They were reacting, he thinks, to the revenue-valuing views of Wall Street analysts. Williams itself has stuck to net, says Sunderman, because it mirrors the way the company manages its trading risk. He thinks grossing up revenues just clouds the picture.
Plainly the practice produces at least one financial perversity, putting a dismal cast on profit margins. Dynegy, for example, may be No. 30 in revenues on the 500, but it is No. 317 in return on revenues.
If there was initially no authoritative support for gross reporting, a pillar materialized in 1998, when the Emerging Issues Task Force (EITF) of the Financial Accounting Standards Board (FASB) specifically debated how energy trading contracts should be handled. When gross vs. net came up for decision, the task force actually reached a preliminary conclusion that all contracts should be presented net--which would have financially shriveled Enron and others. But then, says FASB's Tim Lucas, who chairs EITF, "somebody pointed out we really didn't know enough about what we were talking about, and we backed away"--all the way, in fact, to declaring straight out that either gross or net was okay. "With hindsight," says Lucas, "maybe it would have been nice if we had gone a little further--or even more than that." He calls gross vs. net a "good issue," meaning that the divergence in the way companies report deserves the attention of FASB or its EITF arm.
Robert Herdman, chief accountant of the SEC, whose five months in that post have been Enron-challenged, appears to agree. He told FORTUNE he is "sure" the EITF will again take up the question of energy trading--a telling comment, because the SEC often sets EITF's agenda. And when that moment arrives, said Herdman, "it would certainly be sensible and consistent with other EITF activities with respect to revenue recognition to deal with and narrow this one way or the other."
A small example as to why net might be better than gross: Suppose two energy companies wanting to appear both big and vibrant connived to trade, between themselves, a multitude of contracts, all presented "gross." This scheme would do nothing for profits, but for both companies it would create giant revenues. These folks might whip right by Wal-Mart on the 500 list.
How about that for a possible plot? It's not absurd to imagine, says EITF's Lucas, adding, "There's some overlap between that and the Global Crossing issue." According to allegations that are now part of an SEC investigation (and that have been denied by Global Crossing), the company swapped fiber-optic capacity with competitors for no other purpose than to create, by accounting, revenues and profits. No question about it: The creativity of corporate accounting knows no bounds.
The beginning is at http://www.fortune.com/indexw.jhtml?channel=artcol.jhtml&doc_id=207024
"The Un-Enron Duke Energy used to hate explaining why it wasn't more like its Houston rival. Not anymore," By Nelson D. Schwartz, FORTUNE, April 15, 2002, pp. 132-140, --- http://www.fortune.com/indexw.jhtml?channel=artcol.jhtml&doc_id=207017
A few years back, Duke Energy CEO Rick Priory left Charlotte, N.C., and headed north to make one of his periodic pitches to Wall Street. As far as Priory was concerned, he had a pretty exciting story to tell, and it went something like this: Duke, which had a long, proud history as a utility in the Carolinas, was about to enter the big time. It was building dozens of efficient, gas-fired plants that would supply electricity to juice-starved markets. It was constructing scores of pipelines and underground storage caverns to take advantage of surging demand for natural gas. And all that shiny new big iron would give Duke's energy traders a leg up in ever volatile commodity markets.
But the suits from the Street seemed--well, they seemed bored. The problem was that Priory had followed an awfully tough act. Literally minutes before he came onstage, the investors and analysts gathered at the midtown Manhattan hotel had been wowed by the top brass of a certain Houston-based energy giant. This company's model was tons sexier and a lot simpler than Duke's--just ditch the power plants and other old-economy relics, and trade your way to glory. Priory stuck to his script, but it was rough going, and the sting of Wall Street's skepticism is fresh even now. "I explained our approach, but the analysts said the story they'd heard before ours was exactly the opposite," he recalls. "They said, 'Ken told us you don't need assets.' I still remember defending myself, saying you have to be able to produce and deliver energy as well as trade it."
As you've no doubt guessed by now, the company with the oh-so-clever strategy was Enron, and "Ken" was Kenneth Lay, Enron's now disgraced former chairman. For Priory, obviously, this is a tale of sweet vindication. Because while nothing is more fashionable in corporate America today than dumping on Enron, conservative Duke has deliberately been the un-Enron for years.
And these days that's really paying off: Revenues rose from $49.3 billion in 2000 to $59.5 billion in 2001, putting Duke at No. 14 on this year's FORTUNE 500. Profits--they seem to be mostly real at Duke, not the product of some accountant's sleight of hand--totaled almost $2 billion. True, the company's giant revenue jump is partly attributable to the way energy traders book sales (see The Revenue Games People Play). But it's notable that while Duke and No. 13 American Electric Power posted nearly the same amount in revenues, Duke earned almost twice as much. Better still, while the stock market has drifted downward, shares of Duke have risen 51% since the beginning of 2000, outperforming both the Dow and the S&P 500 as well as market darlings like GE and Exxon Mobil.
That performance is all the more remarkable because last year will almost certainly go down as one of the nastiest patches in recent memory for the energy industry--and not just because of Enron. "On Jan. 2, 2001, all hell broke loose, and it didn't stop," says Priory, referring to last winter's energy crisis in California, when hundreds of thousands of people suffered through rolling blackouts. Priory then ticks off the rest of 2001's troubles: collapsing prices for electricity and natural gas as a result of the slowing economy, the terrorist attacks of Sept. 11, the bankruptcy of Enron, and Wall Street's fear that other energy firms like Duke might get caught in the undertow. "I just can't imagine 2002 being that tough," says Priory.
So far--knock on wood--it hasn't been. On March 14, Duke completed its $8 billion acquisition of Canada's Westcoast Energy, reinforcing its position as one of North America's largest natural-gas players. And over the next few months, as temperatures rise and electricity demand soars, Duke plans to bring 11 new gas-fired power plants online across the country, adding 6,600 megawatts in generating capacity. That's enough juice to power more than six million homes, and it will put Duke among the country's very largest power producers.
Continued at http://www.fortune.com/indexw.jhtml?channel=artcol.jhtml&doc_id=207017
Amy Dunbar sent a message regarding the
following paper at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=301475
"Enron and the Dark Side of Shareholder Value" Tulane Law Review, May 2002, Forthcoming
by WILLIAM WILSON BRATTON The George Washington University Law School
This article addresses the implications that the Enron collapse holds out for the self regulatory system of corporate governance. The case shows that the incentive structure that motivates actors in the system generates much less powerful checks against abuse than many observers have believed. Even as academics have proclaimed rising governance standards, some standards have declined, particularly those addressed to the numerology of shareholder value. The article's inquiry begins with Enron's business plan. The article asserts that there may be more to Enron's "virtual firm" strategy than meets the eye beholding a firm in collapse. The article restates the strategy as an application of the incomplete contracts theory of the firm that prevails in microeconomics today and asserts that Enron failed because its pursuit of immediate shareholder value caused it to misapply the economics, mistaking its own inflated stock market capitalization for fundamental value. The article proceeds to Enron's collapse, telling four causation stories. This ex ante description draws on information available to the actors who forced Enron into bankruptcy in December 2001. The discussion accounts for the behavior of Enron's principals by reference to the shareholder value norm and Enron's corporate culture. Finally, the article takes up the self regulatory system of corporate governance, asserting that the case justifies no fundamental reform. The costs of any significant new regulation can outweigh the compliance yield, particularly in a system committed to open a wide field for entrepreneurial risk taking. If we seek high returns, we must discount for the risk that rationality and reputation will sometimes prove inadequate as constraints. At the same time, we should hold critical gatekeepers, particularly auditors, to high professional standards. The article argues that present reform discussions respecting the audit function do not adequately confront the problem of capture demonstrated in this case.
The combined company of J.P. Morgan and Chase is called JPM. Why has its shares dropped in value by over $40 billion (37%), which is a price drop that is very uncommon for banks?
"Risky Business: Chase took a hit in the recession. It took another hit on Enron. The deeper problem, though, goes further back," by Michele Asselin, Fortune, April 15, 2002, pp. 116-122 --- http://www.fortune.com/indexw.jhtml?channel=artcol.jhtml&doc_id=207012
J.P. Morgan Chase is a powerhouse in the debt business...
J.P. Morgan had a second reason for minimizing credit risk. That great oddsmaker known as Mr. Market was saying that loans were a lot more expensive than they appeared in the glow of a robust late-1990s economy. The proof was the cost of credit derivatives. These financial instruments, which J.P. Morgan had helped pioneer, allow banks to hedge, or buy "insurance policies" on their loan portfolios, from hedge funds, corporations, or other investors. The banks pay investors "spreads" (or insurance premiums, if you will) on the derivatives. And in the rare case of a default, the investors providing "insurance" must cover the loss. But J.P. Morgan was finding that the spreads it had to pay were typically exceeding the interest income it was getting on the loans. Conclusion: Most corporate loans were losers. "We decided many credits were just a subsidy to borrowers," says a former J.P. Morgan manager.
So in 1997, J.P. Morgan launched a campaign to reduce its at-risk capital for its credit portfolio by 50%, from $5 billion to $2.5 billion--hedging some loans and selling off others, often at a loss. Within 18 months the bank had achieved its goal. It had shed or hedged credit to a flock of companies--including Kmart, Global Crossing, and, yes, Enron. Think about those names a second.
Harrison acknowledges what he calls a "healthy debate" over the two risk philosophies--but says that ultimately, the best of both philosophies emerged. "Do I wish that we'd spent a few more dollars hedging our Enron exposure?" he asks. "Yes, but if foresight were 20/20, there'd be a lot more billionaires." Harrison says that J.P. Morgan damaged its investment-banking business by withdrawing credit. The combined bank wouldn't make the same mistake.
But a number of J.P. Morgan's risk managers strongly disagreed. They argued that reining in loans hadn't driven away clients at the old Morgan; nor would it do so at the merged bank. Seven of the top ten global credit risk managers from J.P. Morgan have since left the company.
Judging from the scalding headlines and investor rage of recent months, J.P. Morgan Chase picked the wrong path. It boosted telecom lending in 1999 and 2000, just before the sector crashed. It plowed its own capital into tech highfliers like StarMedia and TheStreet.com at the bubble's apex. And it kept lending to many of the same companies that the old J.P. Morgan had pulled away from--and which have since blown up. Scoffs Mike Mayo of Prudential Securities, one of the few research analysts openly critical of the banking powerhouse: "The only fad they missed was Hula-Hoops."
Now the risk has come home to roost. Start with Enron, which was one of J.P. Morgan's biggest clients. So far Morgan has written off $456 million in bad credits to Enron, equal to three-quarters of its total revenues from mergers and acquisitions in the second half of last year. Then there are those fallen angels, Global Crossing and Kmart, which had also borrowed tens of millions of dollars from Morgan. It has booked $351 million in losses on Argentina. Now the jangling suspense centers on telecom. Morgan is a lender to such troubled players as Qwest and WorldCom.
Management blames the Enron mess for unfairly hammering its stock and tarnishing its reputation. For Harrison, Enron is a once-in-a-lifetime, unforeseeable event, not the legacy of flawed risk management. "Enron is the ultimate perfect storm," he says. Adds vice chairman Marc Shapiro: "The Enron effect is all about headline risk, not real risk. But bad PR can have a real economic effect--just look at our stock price!" In part, they're correct. No creditors anticipated Enron's demise. What rightly disturbs investors, though, is that Morgan extended such massive credit to a single customer.
Begin with the lines of credit Morgan offered Enron. Blue-chip companies crave such lender promises as a backup source for borrowing. If investors refuse to buy its commercial paper, a company can always raise money by tapping its credit lines. But that means companies typically use these lines, which aren't backed up by assets, when they get in trouble--and that can spell danger for lenders. Last October, when Enron could no longer sell its commercial paper--and, as we now know, was just weeks away from bankruptcy--the company drew down its lines from Morgan. The bank had to swallow $216 million in losses from credit lines and other unsecured loans.
The Enron affair has also sprung a grisly surprise. A group of insurers and one bank are refusing to repay $1.13 billion in commodities financing that Morgan fully counted on collecting. The money went through Mahonia, a trading company that Enron and Morgan established in the Channel Islands. Using Mahonia as a middleman, Morgan advanced the $1.13 billion to Enron over a series of transactions known as "swaps." According to Morgan, Enron used the money to purchase oil and gas contracts, then delivered the commodities to Morgan. The bank sold the oil and gas to recoup the funds it had advanced to Enron, pocketing a nice markup for its efforts. Why do such arcane, circular deals at all? "Enron used some of the deals to manage its year-end taxes," says Shapiro. Such arrangements, he says, are standard practice between commodities companies and their banks.
Trouble is, Enron defaulted on its contracts, and the insurance companies that had guaranteed them are now refusing to pay Morgan. A lawsuit has ensued. The insurance companies say that the commodities deals were, in fact, disguised loans, and that Morgan used fraud to obtain the guarantees. Harrison adamantly denies the charge. "Clearly, there was no fraud on our part. The insurance companies understood what they were underwriting," he says. "The contract language is clear and allows no outs at all. We believe we should prevail, and that the insurance companies will have to honor their agreements and pay us."
The early skirmishing doesn't look encouraging for Morgan. In early March a federal judge denied its motion to force insurers to pay immediately. One legal expert says the bank faces an uphill battle to collect.
Continued at http://www.fortune.com/indexw.jhtml?channel=artcol.jhtml&doc_id=207012
From Risk News on April 12, 2002 Risk Waters Group [RiskWaters@lb.bcentral.com]
Good news for the energy markets this week, as the US Senate blocked moves to re-regulate OTC energy derivatives trading. The Senate voted down a proposal by Dianne Feinstein, a Democratic Senator from California, for the Commodity Futures Trading Commission to regulate OTC trading in energy and metals, following Enron's collapse.
Meanwhile, Citigroup, which failed in efforts to create a merger of e-FX portals FXall and Atriax, ahead of Atriax's closure late last week, joined both State Street's FX Connect and FXall. Citi lost millions along with Deutsche and JP Morgan in their failed Ariax endeavour.
For the latest headlines on the fallout from Enron, visit The Financial Times at: http://specials.ft.com/enron/index.html
The Financial Times takes a deeper look at Enron and the events surrounding its collapse in a special series of features on the collapsed energy trader --- http://specials.ft.com/enron/FT3GIIYBNXC.html
As congress prepares for an intense round of questioning of Enron directors and officials, there is a growing suspicion that at the heart of the once-mighty energy trader was a financial hole. Evidence is accumulating that the Houston-based group, which boasted of being asset-light, may also have been light on profitability at core operations --- http://specials.ft.com/enron/FT3648VA9XC.html
April 2 Message from Elliot Kamlet SUNY Account [ekamlet@BINGHAMTON.EDU]
Two very distinct questions here. In terms of solvency, I believe Andersen is insolvent and they will realize it soon. Some partners are also questioning AA's solvency.
Character and integrity? I read that AA agreed to pay $200+ million relating to the BFA audit. The actual document, I assume for I have not seen it, contained all kinds of reasons why AA might not complete the deal and one of those reasons would be the inability of its insurance company to pay a certain portion of the promised funds. Therefore, they are still abiding by the agreement since the insurance company reneged.
The insurance company reneged because AA did not pay a premium last week.
Character and integrity? When faced with financial ruin, AA partners are acting as I believe most business people would and do - get the best lawyers they can to salvage as much money as they can.
See today's Wall Street Journal
Message from Barbara Scofield on April 3, 2002
Some members of the listserve expressed an interest in my student project for Accounting Information Systems classes in implementing the payroll system of Waren Distributing Company from the System Understanding Aid practice set in ACCESS.
I have completed the solution to the ACCESS portion of the project (and some of the other requirements), and I have listed the URL for the project and solution below. The solution does not meet any criteria for good naming conventions of queries at this time, but it does give checkfigures that students can use and the solution website should lead you through the sequence of queries.
After solving my project, I adjusted the assignment to make some aspects simpler and to prevent students from getting correct answers when using shortcuts.
The project is at www.utpb.edu/courses/scofield/ACCT4311/Access.htm
The solution (under construction) is at (please contact Barbara)
Barbara W. Scofield, PhD, CPA
Coordinator of Graduate Business Studies
The University of Texas of the Permian Basin
4901 E. University Odessa, TX 79762 915-552-2183 FAX 915-552-2174 firstname.lastname@example.org
From Double Entries on March 28, 2002
The International Accounting Standards Board (IASB) appears concerned to note that a number of press articles quote Sir David Tweedie, Chairman of the IASB, as stating that Enron's collapse and other recent accounting irregularities could not have occurred under international accounting standards (IAS). The IASB have issued a statement to make clear that these reports are not correct. Sir David stated his views on Enron's collapse when he testified before the Committee on Banking, Housing and Urban Affairs of the United States Senate on 14 February 2002. See our story at http://accountingeducation.com/news/news2717.html for more details
Congress should do more to protect individual investors and ensure fair competition, while approaching accounting reform with long- term solutions instead of quick-fix proposals, according to 73% of the 800 registered voters surveyed by Peter D. Hart Research Associates and Public Opinion Strategies on behalf of Deloitte & Touche. The survey is among the first to gauge the investing public's opinion on ways to mend the American financial system and restore public confidence. Click through to our full story at http://accountingeducation.com/news/news2704.html for further comment on the survey and from Deloitte & Touche
Enron Sold Recipes on How to Cook the Books and Provided Its Own Chefs as Teachers
"Enron Offered Management Aid to Companies," by David Barboza, The New York Times, April 10, 2002 --- http://www.nytimes.com/2002/04/10/business/10MANA.html
HOUSTON, April 9 — The sales pitch to major corporations went something like this: Having trouble with cash flow or meeting profit forecasts? We can help you manage the numbers, and even put a little cash in your pocket.
The financial expert was the Enron Corporation (news/quote), which until its sudden collapse last year had been widely admired in financial circles for the innovative techniques — like off-balance-sheet partnerships — that it used to enhance its performance.
But Enron did not just find creative ways to manage its own cash flow and profits. It marketed that expertise to other major corporations, including AT&T (news/quote), Eli Lilly & Company (news/quote), Owens-Illinois, Lockheed Martin and Qwest Communications (news/quote), according to documents and interviews with more than a dozen former Enron executives.
It is unclear exactly how many corporations hired Enron explicitly to provide financial management services. But at least six big companies signed complicated deals, intended to enhance their results with financing and accounting ploys. Most of the deals involved purchasing other Enron services. Scores of smaller companies may also have participated, executives said.
Enron and a customer might, for instance, agree to swap telecommunications services, use shell corporations or take advantage of accounting loopholes to improve each other's balance sheet or income statement, former Enron officials said.
Few of the companies that signed major deals with Enron would talk about them, while some that rejected Enron's proposals termed them peculiar. But former Enron employees who marketed the services said that their mission was clear: to sell a form of "structured finance" that could accelerate a customer's earnings or otherwise dress up the corporate books.
"Ultimately, that was my job — to help companies make earnings," said one former executive of Enron's broadband services unit who insisted on not being identified for fear of being drawn into litigation. "This was one of the secrets of Enron."
One internal training document for the sales staff of the Enron Energy Services unit described the financial advantages to be offered prospective clients, including "acceleration of earnings/cash from outsourcing for both EES and our customer" and the promise to "unlock benefits from a difficult tax position that the customer may have."
None of this would be unusual for Wall Street investment banks like Merrill Lynch (news/quote) or J. P. Morgan Chase (news/quote), which in recent years have used a wide range of derivatives and other structured finance products to help big corporations reduce their taxes and deliver just the right amount of profits, quarter after quarter.
But the Enron scandal has heightened the sensitivity of regulators, investors and corporate finance experts to such efforts by underscoring the potential for fraud and deception. And the discovery that Enron was marketing its financial management techniques has only heightened the anxiety of some experts.
"This is outrageous," said Frank Partnoy, a former Wall Street investment banker and now a professor at the University of San Diego School of Law, after reviewing some of Enron's sales presentations. "In some ways, they were polluting the entire financial system. To the extent that others weren't doing this, Enron was going out on the road and showing them how to do it."
Mark Palmer, a spokesman at Enron, declined to comment.
Arthur Levitt, as chairman of the Securities and Exchange Commission during the Internet stock bubble, spoke out strongly against the practice of earnings management in 1998, a view he has reiterated many times. "I fear that we are witnessing an erosion in the quality of earnings, and therefore, the quality of financial reporting," he said. "Managing may be giving way to manipulation."
The critical point, finance experts say, is to distinguish between altogether legal strategies taking advantage of accounting and tax rules to smooth out bumps in quarterly earnings and financial machinations that are so aggressive that the true nature of a company's finances is misrepresented.
"If accounting is just compliance with 10,000 rules, then the party that's expert at gamesmanship can manipulate the rules and help you in exchange for some kind of accommodation fee," said John C. Coffee Jr., a securities law expert at Columbia University Law School.
Former executives said that a culture of "earnings management" permeated Enron. They said it went far beyond the efforts of Andrew S. Fastow, the company's chief financial officer, who was dismissed last October after Enron discovered that he had made more than $30 million from a series of off-balance-sheet partnerships that did business with Enron.
Continued at http://www.nytimes.com/2002/04/10/business/10MANA.html
From Double Entries on April 12, 2002
 FURTHER GOOD COMPLIANCE: AREAS OF SEC FOCUS
SEC Staff made a speech at the annual conference of the National Regulatory Services on April 8, 2002, discussing the furthering of good compliance, and current areas of focus in SEC examinations. The speech by the Director of the Office of Compliance Inspections and Examinations discusses the role of good compliance, the SEC's role, and current areas of examination focus. To access the speech go to http://www.sec.gov/news/speech/spch548.htm
 SEC CHAIRMAN PITT REMARKS AT INAUGURAL LECTURE
On April 4, 2002, U.S. SEC Chairman Harvey L. Pitt spoke at the Kellogg Graduate School of Management and Northwestern Law School in Chicago, Illinois. Among several items discussed, Chairman Pitt noted the SEC's primary concern is to ensure that management's interests are aligned with shareholders' interests. Key to this view, in his mind, is to ensure that, if a company chooses to grant options to corporate managers to create incentives to build value in the company, the options actually work as intended, rather than create an unearned windfall for those managers. See our full article at http://accountingeducation.com/news/news2758.html for more details
What will the U.S. accounting business look like when the dust settles on Arthur Andersen?
THE WALL STREET JOURNAL
Volume III Issue 4
What will the U.S. accounting business look like when the dust settles on Arthur Andersen?
The chart on this page tracks how many clients have left Arthur Andersen and where some of the most prominent are heading. Information is updated as it becomes available.
Business Journal. Andersen is Toast. But its Progeny Can Still Flourish.
By Baruch Lev, Professor of Accounting and Finance, New York University
In the March 18 Manager's Journal, Baruch Lev, Professor of Accounting and Finance, New York University, argues that Arthur Andersen doesn't need a white knight, but rather it needs a chain saw. Professor Lev's proposition is that Andersen should be partitioned into three functionally oriented audit firms; and he defends his proposition on by making five points. First, the accounting industry is already at a dangerously low level. Greater competition leads to improved service and efficiency. Second, it is difficult for U.S. firms to find auditors that do not already audit their competitors : a real concern companies trying to shield intellectual assets. Third, a highly concentrated accounting industry leads to great systematic risk. Customers will pay a greater price of one large audit firm tanks. Fourth, breaking up Andersen into companies based on separate core competencies will allow the interested public to better monitor these smaller companies. Professor Lev notes that past mergers of audit firms were justified by the economies-of-scale argument; but that "mammoth companies also see diseconomies of scale, weakened governance and loss of control."
Greenspan Believes the Market, Not Congress, is Best Regulator
By Greg Ip
In formal remarks on corporate behavior following the collapse of Enron Corp., Federal Reserve Chairman Alan Greenspan argued that the market now is enforcing higher ethical standards, and cautioned lawmakers about increasing regulation aimed at improving the quality of accounting data. Mr. Greenspan stated, "Regulation has, over the years, proven only partially successful in dissuading individuals from playing with rules of accounting." The article reports that some of the new rules being proposed in Congress are a new oversight body for accountants and banning accounting firms from selling both auditing and consulting services to a single company.
Does Accounting Need A 'Big Fix' Reform?
By James S. Turley
Auditors Still Perform Nonaudit Services
By Cassell Bryan-Law
Investors worried about potential conflicts of interest stemming from the practice of big companies hiring their auditing firms for consulting and other nonauditing assignments should check out the numbers: It's still a common practice. A Wall Street Journal analysis of newly disclosed fees paid last year to auditing firms by most of the 30 companies in the Dow Jones Industrial Average shows that 73% of the total reported was for services other than an audit.
For example, last year, Johnson & Johnson paid Pricewaterhouse Coopers $9 million for its audit and $57.8 million for all other services, including $6.7 million for financial-information systems design work. For those in the worried camp, the concern is this: How objective can an accounting firm be in an audit when it is also making millions of dollars providing the same client with other services? Don't such auditors have a financial incentive to go light on the books? For their part, the accounting firms vehemently dispute that the integrity of their audits is compromised by other fees paid by an audit client. They generally say that an audit can be enhanced by the extra knowledge an auditing firm has of a client that it also knows through its consulting arm.
Still, conflict of interest concerns has been picked up in Congress, where a number of legislative proposals would ban accounting firms from selling auditing and consulting services to the same company. Some firms are moving in this direction voluntarily. For example, Walt Disney Company said it would no longer purchase consulting services from the same accounting firm that audits its book, becoming the first major company to make such a move in the wake of Enron's collapse. Disney CEO Michael Eisner said it "seemed to be the right thing to do," given shareholders' concern about such issues.
Suggested Reforms (Including those of Warren Buffet and the Andersen Accounting Firm)
Commentary of Bob Jensen
Bottom-Line Commentary of Bob Jensen: Systemic Problems That Won't Go Away
And that's the way it was on April 12, 2002 with a little help from my friends.
Bob Jensen's main document on the Enron scandal and other accounting frauds is at http://www.trinity.edu/rjensen/fraud.htm
March 2000, Forbes named AccountantsWorld.com as the Best Website on the
Web --- http://accountantsworld.com/.
Some top accountancy links --- http://accountantsworld.com/category.asp?id=Accounting
For accounting news, I prefer AccountingWeb at http://www.accountingweb.com/
Another leading accounting site is AccountingEducation.com at http://www.accountingeducation.com/
Paul Pacter maintains the best international accounting standards and news Website at http://www.iasplus.com/
How stuff works --- http://www.howstuffworks.com/
Jensen's video helpers for MS Excel, MS Access, and other helper videos are at http://www.cs.trinity.edu/~rjensen/video/
Accompanying documentation can be found at http://www.trinity.edu/rjensen/default1.htm and http://www.trinity.edu/rjensen/HelpersVideos.htm
Robert E. Jensen (Bob) http://www.trinity.edu/rjensen
Jesse H. Jones Distinguished Professor of Business Administration
Trinity University, San Antonio, TX 78212-7200
Voice: 210-999-7347 Fax: 210-999-8134 Email: email@example.com