Scandal Updates on June
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
$600 million restated financial statements look like a mistake in a child's
allowance, the U.S. Treasury has admitted an accounting error and a resulting
loss of $17.3 billion.
A billion here, a billion there! Yawn!
SCANDALS IN CORPORATE AMERICA In the wake of the
Anderson guilty verdict, the government is gearing up to go after top
executives, and possibly corporations, on charges involving everything from
insider trading to perjury. All of the targets deny wrongdoing. And with the
hurdles that prosecutors have to clear, winning convictions won't be easy.
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RESTORING TRUST IN CORPORATE AMERICA Rarely have
business and its leaders been held in such low esteem. Yet even as the crisis
becomes more disruptive for the market and economy, corporations have remained
silent. Why don't more CEOs speak up?
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IN THE AFTERMATH of Enron, the tarnished auditing
profession has mounted what might be called the "complexity defense."
This involves frowning seriously, intoning a few befuddling sentences, then
sighing that audits involve close-call judgments that reasonable experts could
debate. According to this defense, it isn't fair to beat up on auditors as they
wrestle with the finer points of derivatives or lease receivables -- if they
make calls that are questionable, that's because the material is so difficult.
Heck, it's not as though auditors stand by dumbly while something obviously bad
happens, such as money being siphoned off for the boss's condo or golf course.
Washington Post Editorial, June 1, 2002 --- http://www.washingtonpost.com/wp-dyn/articles/A49512-2002Jun2.html
[firms] in the audit world and the Wall Street firms have obviously been
lobbying intensively for months to prevent effective action in these areas. We
know that some of those people have met with Chairman Pitt. I believe that he
has strongly held views about a number of these issues that predate his arrival
as chairman at the SEC.
Damon Silvers (See below)
Accounting Tricks and Creative Accounting Schemes Intended to Mislead Investors, Creditors, and Employees --- http://www.trinity.edu/rjensen//theory/00overview/AccountingTricks.htm
State of Accountancy in
the Year 2002: My Lectures
for Germany (Augsburg and
Rothenburg) in June --- http://www.trinity.edu/rjensen/FraudConclusion.htm
I have placed a draft of my forthcoming lectures this month in Germany. Some may find some value in these and many will find issues to dispute. I would love to hear about any suggestions for improvements. My email address is email@example.com
The accounting profession's self-regulatory system was caught in the cross-hairs of a GAO report issued this week at the request of Representative John Dingell. Limitations were highlighted in the report of "a system that is fragmented, is not well-coordinated, and has a disciplinary function that is widely perceived to be ineffective." http://www.accountingweb.com/item/83936
What are the three main problems facing the profession of accountancy at the present time?
under greed, with stock options and tax shelters for all.
Proposed revision of the U.S. Pledge of Allegiance following a June 26, 2002 U.S. court decision that the present version is unconstitutional.
On June 26, 2002, the SEC charged WorldCom with massive accounting fraud in a scandal that will surpass the Enron scandal in losses to shareholders, creditors, and jobs. WorldCom made the following admissions on June 25, 2002 at http://www.worldcom.com/about_the_company/press_releases/display.phtml?cr/20020625
CLINTON, Miss., June 25, 2002 – WorldCom, Inc. (Nasdaq: WCOM, MCIT) today announced it intends to restate its financial statements for 2001 and the first quarter of 2002. As a result of an internal audit of the company’s capital expenditure accounting, it was determined that certain transfers from line cost expenses to capital accounts during this period were not made in accordance with generally accepted accounting principles (GAAP). The amount of these transfers was $3.055 billion for 2001 and $797 million for first quarter 2002. Without these transfers, the company’s reported EBITDA would be reduced to $6.339 billion for 2001 and $1.368 billion for first quarter 2002, and the company would have reported a net loss for 2001 and for the first quarter of 2002.
The company promptly notified its recently engaged external auditors, KPMG LLP, and has asked KPMG to undertake a comprehensive audit of the company’s financial statements for 2001 and 2002. The company also notified Andersen LLP, which had audited the company’s financial statements for 2001 and reviewed such statements for first quarter 2002, promptly upon discovering these transfers. On June 24, 2002, Andersen advised WorldCom that in light of the inappropriate transfers of line costs, Andersen’s audit report on the company’s financial statements for 2001 and Andersen’s review of the company’s financial statements for the first quarter of 2002 could not be relied upon.
The company will issue unaudited financial statements for 2001 and for the first quarter of 2002 as soon as practicable. When an audit is completed, the company will provide new audited financial statements for all required periods. Also, WorldCom is reviewing its financial guidance.
The company has terminated Scott Sullivan as chief financial officer and secretary. The company has accepted the resignation of David Myers as senior vice president and controller.
WorldCom has notified the Securities and Exchange Commission (SEC) of these events. The Audit Committee of the Board of Directors has retained William R. McLucas, of the law firm of Wilmer, Cutler & Pickering, former Chief of the Enforcement Division of the SEC, to conduct an independent investigation of the matter. This evening, WorldCom also notified its lead bank lenders of these events.
The expected restatement of operating results for 2001 and 2002 is not expected to have an impact on the Company’s cash position and will not affect WorldCom’s customers or services. WorldCom has no debt maturing during the next two quarters.
“Our senior management team is shocked by these discoveries,” said John Sidgmore, appointed WorldCom CEO on April 29, 2002. “We are committed to operating WorldCom in accordance with the highest ethical standards.”
“I want to assure our customers and employees that the company remains viable and committed to a long-term future. Our services are in no way affected by this matter, and our dedication to meeting customer needs remains unwavering,” added Sidgmore. “I have made a commitment to driving fundamental change at WorldCom, and this matter will not deter the new management team from fulfilling our plans.”
Actions to Improve Liquidity and Operational Performance
As Sidgmore previously announced, WorldCom will continue its efforts to restructure the company to better position itself for future growth. These efforts include:
Cutting capital expenditures significantly in 2002. We intend 2003 capital expenditures will be $2.1 billion on an annual basis.
Downsizing our workforce by 17,000, beginning this Friday, which is expected to save $900 million on an annual basis. This downsizing is primarily composed of discontinued operations, operations & technology functions, attrition and contractor terminations.
Selling a series of non-core businesses, including exiting the wireless resale business, which alone will save $700 million annually. The company is also exploring the sale of other wireless assets and certain South American assets. These sales will reduce losses associated with these operations and allow the company to focus on its core businesses.
Paying Series D, E and F preferred stock dividends in common stock rather than cash, deferring dividends on MCI QUIPS, and discontinuing the MCI tracker dividend, saving approximately $375 million annually.
Continuing discussions with our bank lenders.
Creating a new position of Chief Service and Quality Officer to keep an eye focused on our customer services during this restructuring.
“We intend to create $2 billion a year in cash savings in addition to any cash generated from our business operations,” said Sidgmore. “By focusing on these steps, I am convinced WorldCom will emerge a stronger, more competitive player.”
Contrary to the optimism expressed above, most analysts are predicting that WorldCom will declare bankruptcy in a matter of months. Unlike the Enron scandal where accounting deception was exceedingly complex in very complicated SPE and derivatives accounting schemes, it appears that WorldCom and its Andersen auditors allowed very elementary and blatant violations of GAAP to go undetected.
This morning on June 27, 2002, I found some interesting items in the reported prior-year SEC 10-K report for WorldCom and its Subsidiaries:
|Net income (in millions)||$4,013||$4,153||$1,501|
|Taxes paid (in millions)||$106||$452||$148|
The enormous disparity between income reported to the public and taxes actually paid on income are consistent with the following IRS study:
An IRS study released this week shows a growing gap between figures reported to investors and figures reported for tax income. With all the scrutiny on accounting practices these days, the question is being asked - are corporations telling the truth to the IRS? To investors? To anyone?
Such results highlight the fact that audited GAAP figures reported to investors have lost credibility. Three problems account for this. One is that bad audits have become routine such that too many companies either have to belatedly adjust accounting reports or errors and fraud go undetected. The second major problem is that the powerful corporate lobby and its friends in the U.S. Legislature have muscled sickening tax laws and bad GAAP. The third problem is that in spite of a media show of concern, corporate America still has a sufficient number of U.S. senators, congressional representatives, and accounting/auditing standard setters under control such that serious reforms are repeatedly derailed. Appeals to virtue and ethics just are not going to solve this problem until compensation and taxation laws and regulations are fundamentally revised to impede moral hazard.One example is the case of employee stock options accounting. Corporate lobbyists muscled the FASB and the SEC into not booking stock options as expenses for GAAP reporting purposes. However, corporate America lobbied for enormous tax benefits that are given to corporations when stock options are exercised (even though these options are not booked as corporate expenses). Following the Enron scandal, powerful investors like Warren Buffet and the Chairman of the Federal Reserve Board, Alan Greenspan, have made strong efforts to book stock options as expenses, but even more powerful leaders like George Bush have blocked reform on stock options accounting
For more details, study the an
examination that I gave to my students in April 2002 --- http://www.cs.trinity.edu/~rjensen/Exams/5341sp02/exam02/
Also see http://www.trinity.edu/rjensen/theory/sfas123/jensen01.htm
For example, in its Year 2000 annual report, Cisco Systems reported $2.67 billion in profits, but managed to wipe out nearly all income taxes with a $2.5 billion benefit from the exercise of employee stock options (ESOs). In a similar manner, WorldCom reported $585 million in 1999 and $124 million in 2000 tax benefits added to paid-in capital from exercise of ESOs.
under greed, with stock options and tax shelters for all.
Proposed revision of the U.S. Pledge of Allegiance following a U.S. June 26, 2002 court decision that the present version is unconstitutional.
Bob Jensen's threads on the Enron/Andersen scandals are at http://www.trinity.edu/rjensen/fraud.htm
Bob Jensen's SPE threads are at http://www.trinity.edu/rjensen//theory/00overview/speOverview.htm
Bob Jensen's threads on accounting theory are at http://www.trinity.edu/rjensen/theory.htm
Bob Jensen's threads on the state of accountancy can be found at http://www.trinity.edu/rjensen/FraudConclusion.htm
Remember that passage in the Senate is a long way from getting Congress to buy into proposed legislation and vice versa.
From the June 26 edition of FEI Express
Key Provisions of the Sarbane's Accounting Reform Bill
It now looks very likely that a bill will be passed by the Senate as early as July 9th as a result of the post-Enron hearings and reform efforts. FEI was active in the process, getting key provisions in the bill and changing unpalatable sections. There is still much work to be done and the final bill must be reconciled with the House. I want to send a special thank you to those FEI members who we recently asked to write their Senator regarding this legislation. You should know that your letters were instrumental in getting several pieces of FEI's recommendations included. The legislation was approved out of the Senate Banking Committee on June 18 by a vote of 17-4. While the bill still has a long way to go before it becomes law, I believe that this legislation represents a step in the right direction and will help reform the accounting profession. Again, thank you to all who wrote and called; your efforts are extremely appreciated!
Here are some of the key provisions:
- Strong Accounting Oversight Board with 5 full-time members, 2 members must be CPAs. SEC would have oversight and enforcement authority and the board would establish auditing, quality control and independence standards and rules.
- Strong auditor independence rules, requires SEC preapproval for non-audit services. Audit partners will be required to rotate every 5 years, also calls for GAO study of mandatory rotation of accounting firms.
- CEO/CFO forfeiture of bonuses and profits when there is an accounting restatement.
- Prohibition of insider trades during pension blackout periods.
- CEO/CFO certification of financial statements and company disclosures.
- Code of ethics for senior financial officers.
- Audit committee disclosure of a financial expert.
- Deleted provision requiring a SEC study on stock option accounting.
"Too many masters to serve"
I had a fun meeting with Bennett Stewart, one of the co-founders of EVA-famed Stern Stewart. He's had an incredible experience with many, many companies like Siemens, Sony and Toys 'R Us since the 1993 Fortune magazine article on EVA.
Really EVA is about creating a compensation system that focuses on the "incentive" part of "incentive compensation." It is about metrics that are meaningful toward driving value. Metrics that can be controlled by the management team and measurement of those metrics in a way that encourages the desired behavior. EVA takes the accounting data and makes adjustments that Stern Stewart feels provides more appropriate incentives for the management team. Incentive comp is then tied to the EVA metrics and results.
In the course of conversation, Bennett was talking about the adjustments they make and the accounting model. The need for EVA comes from the accounting model's flaws. He put it simply saying that the "accounting model has too many masters to serve." I've said this often, but in less crisp and clear terms. It is the essence of all of our problems in accounting. Rules-based standards, disclosure overload and the insertion of fair value accounting on top of historical cost accounting, all stem from a system that is trying to serve too many masters. We need a clear objective for the financial statements and accounting model. We should serve that objective fully and relegate the other objectives to the market, or at worst supplemental reports. I think the top objective should be to help investors assess the current and expected cash flows. If the standard setters could focus on this, and eliminate standards that distort this focus, we would have real reform.
SEC Announces Proposal for a Public Accountability Board and other SEC News
Last week, the SEC voted unanimously to propose a series of rules aimed at enhancing the reliability and integrity of public company financial reporting through improved oversight of the auditing process. A new nine-member (at least six independent of the public accounting profession) private sector body, referred to as the Public Accountability Board (PAB), is to provide such oversight. The proposed PAB anticipated to be in place by the end of 2002 would be funded through membership fees. All public companies would be required to be adjunct members of the PAB and assist in its funding. The SEC commented that if pending legislation (Oxley and Sarbanes Bills) in Congress were enacted to achieve the same result as the SEC proposals, the SEC would defer their proposal and instead implement Congress's mandate. Comment period is 60 days after publication in the Federal Register.
As reported in the last Express, the SEC has issued two proposed rules for comment. Complete details of the rules and filing dates were posted to the SEC website this week. Additional Form 8-K Disclosure Requirements and Acceleration of Filing Date, comments due August 26th and Certification of Disclosure in Companies' Quarterly and Annual Reports, comments due August 19th.
Reply from George Boyd
But to be fair, Bob,
George Bush has now demanded reform of business law and transparent accounting standards ---- from Palestinians!
From the June 14 edition of FEI Express
SEC Proposals on: Certification of Financial Statements and Additional Form 8K Requirements The SEC announced this week an additional 2 proposed new rules for public comment. The first would require a company's principal executive officer and principal financial officer to certify the contents of the company's quarterly and annual reports. This proposal is intended to enhance investor confidence in the quality of companies' periodic reports. The Commission also proposed that several new items or events be reported on Form 8-K in an effort to improve the quality, amount and timeliness of public disclosure of extraordinary corporate events. In addition, the Commission proposed that Form 8-K reports, also known as current reports, be filed within two business days instead of the current five to 15 days. Comments on each proposal are due within 60 days of publication in the federal register.
In other SEC news, the SEC announced late Thursday that they will be holding an open meeting on Thursday, June 20th to consider proposing rules to improve the oversight of the auditing process. "The proposed rules would create the framework for a new private sector regulatory scheme for the accountants that audit or review financial statements filed with the Commission. The proposed rules also would reform oversight and improve the accountability of auditors of public companies, thereby enhancing the reliability and integrity of the financial reporting process. Under the proposed framework, a new organization, among other things, would (1) conduct reviews of accounting firms' quality controls, (2) discipline accountants for unethical or incompetent conduct, or other violations of professional standards, and (3) either set or rely on designated private sector bodies to set auditing, quality control and ethics standards." View the other planned agenda items for the open meeting.
Bear Stearns Conference Here's a presentation I made as part of a debate at a technology investor conference hosted by Bear Stearns. You can listen to a replay of the debate on their system at 888-888-9540, PIN # 4520.
USC Highlights I spoke at the USC Financial Reporting Conference last week. Here's some of the highlights of the day, as promised in my last issue. Jackson Day, SEC Deputy Chief Accountant, opened the meeting. His key points were:
Financial reporting is on the front page of our national papers every day. He encouraged all the attendees to step up to the challenge and improve financial reporting. Critical accounting policies - one part is a focus on the estimates made in the financial statements. Alternative estimates that could have been made should be disclosed. Restatement of accounting policies is not the purpose of the disclosure. Also key choices that a company made between alternative policies should be disclosed. Proposals on the horizon - events under 8Ks within two days of the events, and some may be required by the day after the event. About a dozen events were identified, including cases where a company waives codes of conducts or permits exceptions to those policies. Accounting standards setting - substance must be addressed, not the form. The SEC is seeing cases where companies are undertaking transactions for which accounting results are the only purpose. SAS 50 letters are proposed to be eliminated by the auditing standards board and that move is supported by the SEC. These letters address specific transactions and give an accounting firm's opinion on the accounting treatment.
Ed Jenkins, FASB Chairman - spoke to the "E" word: Enron. FASB's focus has to be on the customer, the users of financial statements. They have no authority to enforce the standards. Their job is high-quality standards that will create transparency for the capital markets.
Enron's own investigations and restatements acknowledge that their accounting did not comply with GAAP. The local Andersen office didn't follow the advice of the national technical group.
Consolidations - the FASB is going to issue its SPE work shortly.
Ed also addressed principle-based vs. rule-based standards. The FASB standards are principle-based, but the problem (in his words) is they go on to answer every question that has come up in their comment period and consideration of the standard.
Ed thinks that what needs to be done to get to principle-based standards is: No exceptions to the principle - no more corridor for the pension plan accountings. No more exceptions for derivatives, for example. Companies must account within the intent of the standards. The SEC must also support that application of principle based standards.
On stock option accounting - the IASB's objective is to measure and expense stock options. In the U.S., all options are expensed except those issued to employees on certain terms. Outside the U.S., there are no standards, and even stock appreciation rights are NOT expensed. Ed thinks that if the IASB moves to a standard close to the U.S. standard, that would be a great improvement in global standards.
Documents from Enron chapter 11 bankruptcy available online for free – at www.elaw4enron.com.
Andersen to Cease Auditing Publicly Held Companies http://www.accountingweb.com/item/83460
Andersen: The Story So Far http://www.accountingweb.com/item/76481
PricewaterhouseCoopers released the results of its 2001 securities litigation study on June 10. The results show a marked increase in the number of initial public offering lawsuits, along with record-breaking percentages and settlements for suits involving allegations of improper accounting. http://www.accountingweb.com/item/83117
An IRS study released this week shows a growing gap between figures reported
to investors and figures reported for tax income. With all the scrutiny on
accounting practices these days, the question is being asked - are corporations
telling the truth to the IRS? To investors? To anyone?
Results were released this week of a recent AccountingWEB survey of over 300 practitioners highlighting the actions, attitudes, and changes CPA firms are making in response to audit reform discussions in this post Enron era. The survey, co-sponsored by Sommella Market Strategies, points to complacency in smaller firms, and formal changes in larger firms. Find out what we uncovered in "The Impact of Enron: How Far Will It Go?" http://www.accountingweb.com/item/82862
In his first public appearance since resigning as CEO of Andersen in March, Joseph Berardino this week spoke out against low audit fees, the dangers of placing all the responsibility for accurate financial reporting in the hands of the auditors, and the various systems available for GAAP, pro-forma statements and financial analyst models. http://www.accountingweb.com/item/82747
Read it and Weep
From Business Week Online as Reproduced by SmartPros (May 30, 2002) ---- http://www.smartpros.com/x34230.xml
Still Hoping for More From Harvey Pitt
May 30, 2002 (Business Week Online) — Earlier this month, Securities and Exchange Commission Chairman Harvey Pitt convened the first "Investor Summit" to listen and respond to investor complaints. (You can hear a replay of the May 10 discussion on the SEC Web site.) It was, at times, spirited.
Pitt and fellow Commissioners Isaac Hunt and Cynthia Glassman got earfuls -- both from investors at large and from a group of six panelists. Some of the sharpest criticism of the SEC's performance in the current crisis of confidence in Wall Street came from panelist Damon Silvers. He's an associate general counsel with the AFL-CIO, which is the umbrella organization for some 13 million members of different unions, who are beneficiaries of an estimated $5 trillion in pension assets.
After Silvers spoke at the conference, I reached him by phone at his Washington (D.C.) office and asked him to elaborate on the remarks he made and the questions he asked. Edited excerpts of our discussion follow:
Q: At the Investor Summit, you said that the ball is being dropped on reforming "issue after issue." What are those issues?
A: Well, I'll just do a short list for you.
A: The first is the issues surrounding auditors, and in particular the issue of auditor independence and the creation of a public oversight board. The AFL-CIO put a rule-making petition into the [SEC] in December on auditor independence. As far as we can tell, the commission hasn't really done anything in that area. Everyone knows about the mess that auditor-oversight process turned into at the commission, and clearly it hasn't taken any steps to do the minimum in this area that was outlined by [former SEC Chairman] Arthur Levitt in his testimony in the Senate.
Q: Which was?
A: Creating a body that has a majority of nonaccounting industry people, with full enforcement powers and independent financing.
Q: What else?
A: The commission has missed an opportunity to deal with the problem of analysts' conflicts on Wall Street by failing to really do anything meaningful to regulate the power that investment bankers have developed over the analysts in the major Wall Street firms. The SEC also hasn't acted on the problems related to the independence of boards of directors at public companies.
Q: Such as?
A: Both in requiring meaningful independence of audit committee and compensation committee members and in disclosure. Those are the key issues where the commission has failed to act or has acted in a manner that is inadequate.
Q: Pitt wouldn't agree with that, and it's only fair to note that the reforms are a work in progress. In your view, why has the commission dropped the ball?
A: I wish I knew. The big [firms] in the audit world and the Wall Street firms have obviously been lobbying intensively for months to prevent effective action in these areas. We know that some of those people have met with Chairman Pitt. I believe that he has strongly held views about a number of these issues that predate his arrival as chairman at the SEC.
Q: How much of this is a result of there not being a full commission -- two of the five seats remain vacant.
A: I think that is underappreciated in the coverage of these issues. The Commission is, after all, designed to be a deliberative body. And there are currently only three commissioners, one of whom is clearly planning to depart.
Q: Commissioner Isaac Hunt?
A: Right.... There's a need for more diverse perspectives on the commission. I continue to believe that Chairman Pitt has the potential to do the right thing here. And the addition of commissioners with a more diverse set of views would help steer the SEC in that direction.
Q: So you're not in the group of people who think that Pitt no longer has the credibility to remain at the SEC?
A: There are people who have called for him to resign. Common Cause did so on the day of the Investor Summit.... We are critical of Chairman Pitt's performance here, on many levels, severely critical in fact. However, we're not ready to say that there's no hope here and that he's incapable of doing the right thing. If I believed that, I'm not sure that I would have participated in the summit.
Q: Some suspected the summit was 100% public relations -- nothing substantive. What's your view?
A: It might have been designed to be that way. I don't think that's what it was. I think we had substantial exchanges about a number of important issues -- ones in which, prior to the summit, no one really knew what Chairman Pitt's views were.
Q: Such as?
A: Mutual-fund disclosure and "aiding and abetting" liability. That being said, I think the question now is, "What's the follow-up?"
Q: You mentioned the "aiding and abetting" issue, which is a fairly technical set of legal precedents, but a very interesting one and one that's potentially important to investors. Also, I think that you got from Pitt a commitment to work with you on that.
A: Yes, that's right.
Q: Can you explain please what this "aiding and abetting" issue is?
A: This is really an outrageous situation in our securities law. The Supreme Court said in the early '90s, in a case called Central Bank of Denver, that despite the fact that everybody for decades had proceeded on the basis that the securities laws gave investors the right to sue and recover damages from people and institutions that aided and abetted securities fraud.... The Supreme Court found that there was actually no basis for that kind of claim in the statute.
Therefore, investors -- the people who were actually wronged by securities fraud -- could not sue those who aided and abetted.
A: This is important because the typical securities fraud is a product not just of a company that is the actual institution doing the disclosure but of the people who work with that company.
Q: Such as?
A: Investment banks, lawyers, and accountants. In most situations, the investment banks, the lawyers, and the accountants don't interact directly with the shareholder. They do so through the company. Making aiding and abetting no longer recognizable in the courts as something an investor can recover on, they basically made it impossible for investors to go after those folks.
Q: I see.
A: By the way, if you look at the defenses that have been raised by Arthur Andersen and others in the Enron cases, they all rest on this. They all say, basically, even if we did all of these things, even if we did everything you accuse us of doing, it's just aiding and abetting, and you have no right to sue for it.
Q: So what's the upshot for the individual wronged in the Enron case?
A: You're out of luck. If the aiding and abetting case defense holds in the context of Enron, where Enron is bankrupt, unsecured creditors like the investors who got defrauded are unlikely to get hardly anything.
Q: Given that, do the investors need to look to Congress for a fix?
A: Yes, you have to have a congressional fix here. The SEC can't fix it by itself. But what the SEC can do, which is what I was challenging Chairman Pitt to work with us on, the SEC can send a clear message to Congress that this needs to be fixed, and that would be very important.
-- Robert Barker, Business Week Online
And the bottom line is that reform efforts are stalled in Congress and will most likely die in hands of committees that held all of these “spectator” hearings! There will, however, be some really neat new TV commercials for re-election, commercials paid for by the lobbyists.
"Bad Boys Club" by Allan
Sloan, Newsweek, July 1, 2002, pp. 44-46 --- http://www.msnbc.com/news/771098.asp?0bl=-0
After a wave of scandals, corporate America is under pressure to clean up its act. But will anything really change?
July 1 issue — The stock market is tanking and the business world is soured by scandal, but there is some good news. We’ve got a new growth industry: reforming corporate America. More than a dozen proposals from big-name sponsors—ranging from Goldman Sachs and the New York Stock Exchange to President Bush and the Senate Finance Committee—have appeared since Enron became widely recognized as a poster child for dysfunctional capitalism. A Reform of the Month Club, as it were. With so much attention from such influential quarters, something significant is bound to change, right?
THE ANSWER, I’M afraid, is no. At least not yet. And I’m not being some cynical newsie. It’s just that you usually don’t get reform until the people who need to be reformed recognize that there’s a problem. Despite all the pronouncements and blue-ribbon commissions—many of which have worthy suggestions—they don’t remotely represent the views of the people who are truly in a position to make change: America’s chief executive officers.
Our M.B.A. president doesn’t seem to think much is wrong. Bush said Friday that “95 percent or some... huge percentage of the business community are honest and reveal all their assets, got compensation programs that are balanced, but there are some bad apples.” He even opposes a key reform that resident sages like Warren Buffett and Alan Greenspan consider vital to producing honest corporate numbers: treating stock options as an expense on earnings statements. The fact that options value isn’t subtracted from profits has led corporations to give loads of them to CEOs, who make huge profits when the stock rises, but lose nothing when it falls. Standard & Poor’s, not exactly a hotbed of radical activity, is now counting options as an expense when computing profit figures for the influential S&P 500 Index. Vice President Cheney, a former CEO himself, has been noticeably silent on issues of reforming the way corporate America keeps its books. One possible reason is that the company he once ran, Halliburton, is now being investigated for accounting changes adopted during his tenure.
For all the talk from business organizations, we haven’t heard much from working CEOs themselves. But there are exceptions, like Henry Paulson Jr. of Goldman Sachs and Dick Grasso of the New York Stock Exchange. Paulson was especially outspoken. “American business has never been under such scrutiny. To be blunt, much of it is deserved,” he said at the National Press Club in Washington recently. These guys deserve big credit for guts, because they’re risking the wrath of their peers, alienating customers and inviting scrutiny of their institutions, which, they readily admit, are far from perfect. In separate NEWSWEEK interviews, Grasso and Paulson said they have plenty of support among corporate chieftains. But when pressed for specifics, Paulson provided none, and Grasso produced just one: a laudatory letter from John Dillon, CEO of International Paper. But Dillon is head of the Business Roundtable, which already has proposed reforms. Here’s why the CEO silence matters. When the market was going great guns during the ’90s, corporate America proclaimed that the market’s performance was proof that companies were doing the right thing, and that critics of huge executive pay packages and boards cozying up to CEOs were just cranks. Now that the market’s down, CEOs are hiding under their boardroom tables. What will it take to get business to change? Even more bad stock-market news. And we’ve already got plenty. At Friday’s close the S&P 500, a proxy for the broad stock market, was down 35 percent from its high in March of 2000. If you make the very generous assumption that the market will rise 10 percent a year compounded, it would take until the end of 2006 for the S&P to regain the ground it’s lost. So the market would have gone nowhere for almost seven years. If the market’s a report card, that’s a pretty lousy grade. A failing one, in fact.
"System Failure: Corporate America: We Have a Crisis," Fortune Magazine Cover Story, June 24, 2002 --- http://www.fortune.com/indexw.jhtml?channel=artcol.jhtml&doc_id=208314
Goldman Sachs CEO Hank Paulson is not a touchy-feely guy. Even by Wall Street standards, he's fairly buttoned down. But the daily drumbeat of news about horrifying corporate behavior would get to anyone--and it's clearly getting to Paulson. "In my lifetime, American business has never been under such scrutiny, and to be blunt, much of it deserved,'' he said in a recent speech. To FORTUNE he added, "You pick up the paper, and you want to cry.''
You sure do. Every day, it seems, a new scandal bursts into public view. Bankrupt Kmart is under SEC investigation for allegedly cooking the books. Adelphia's founding family is forced to resign in disgrace after it's revealed that members used the company as their own personal piggy bank, dipping into corporate funds to subsidize the Buffalo Sabres hockey team, among other things. Former telecom behemoths WorldCom, Qwest, and Global Crossing are all being investigated. Edison Schools gets spanked by the SEC for booking revenues that the company never actually saw. Dynegy CEO Chuck Watson denies that his company used special-purpose entities to disguise debt a la Enron--until the Wall Street Journal reports that, lo and behold, the company does have one, called Project Alpha. (Watson has just stepped down.) Most recently, of course, Tyco CEO Dennis Kozlowski resigns after informing his board that he is under investigation for evading sales tax on expensive artwork he purchased. Kozlowski has since been indicted--but even before the most recent disclosures, Tyco's stock was pummeled by the widespread suspicion that it used accounting tricks to boost revenues (a claim the company has consistently denied).
Phony earnings, inflated revenues, conflicted Wall Street analysts, directors asleep at the switch--this isn't just a few bad apples we're talking about here. This, my friends, is a systemic breakdown. Nearly every known check on corporate behavior--moral, regulatory, you name it--fell by the wayside, replaced by the stupendous greed that marked the end of the bubble. And that has created a crisis of investor confidence the likes of which hasn't been seen since--well, since the Great Depression.
Even Harvey Pitt and Bill Lerach, who are poles apart on most issues, agree on this point. "I'm really afraid that investor psychology in this country has suffered a very serious blow," says the controversial Lerach, the plaintiffs attorney best known as the lead counsel representing Enron's beleaguered shareholders. SEC Chairman Pitt, who made his name defending big corporations, concurs: "It would be hard to overstate the need to remedy the loss of confidence,'' he said at a recent conference at Stanford Law School. "Restoring public confidence is the No. 1 goal on our agenda."
Declining investor confidence is not the only reason the stock market is hurting, of course. (The S&P 500 is down 10% so far this year, while the Nasdaq has fallen 20%.) For one thing, the world is an unsettling place right now, with Pakistan and India busy saber rattling, the Mideast in turmoil--and the threat of more terrorist attacks on U.S. soil very much in the air. For another, stocks remain high by historical standards: Even with a 20% drop since its peak in March 2000, the price/earnings ratio for the S&P 500 is still 29, compared with the norm of 16.
Despite the constant reports of misconduct, investors can't cast all the blame for the market's troubles on the actions of CEOs and Wall Street analysts--much as they might like to. There was a time not too long ago when everyone, it seemed, was day trading during lunch breaks. As Gail Dudack, chief strategist for SunGard Institutional Brokerage, puts it, "A stock market bubble requires the cooperation of everyone."
Still, the unending revelations--and the high likelihood that there are more to come--have underscored the extent to which the system has gone awry. That has taken a toll on investors' psyches. According to a Pew Forum survey conducted in late March, Americans now think more highly of Washington politicians than they do of business executives. (Yes, it's that bad.) A monthly survey of "investor optimism" conducted by UBS and Gallup shows that the mood among investors today is almost as grim as it was after Sept. 11--and has sunk by nearly half since the giddy days of late 1999 and early 2000. Similarly, the average daily trading volume at Charles Schwab & Co.--another good barometer of investor confidence--is down 54% from the height of the bull market. "People deeply believed, as an article of faith, in the integrity of the system and the markets," Morgan Stanley strategist Barton Biggs wrote recently. "Sure, it may at times have seemed like a casino, but at least it was an honest casino. Now many people are questioning that basic assumption. Are they players in a loser's game?" Investing, notes Vanguard founder John C. Bogle, "is an act of faith." Without that faith--that reported numbers reflect reality, that companies are being run honestly, that Wall Street is playing it straight, and that investors aren't being hoodwinked--our capital markets simply can't function.
Throughout history, bubbles have been followed by crashes--which in turn have been followed by new laws and new rules designed to curb the excesses of the era just ended. After the South Sea bubble in 1720, points out Columbia University law professor John Coffee, the formation of new corporations was banned for more than 100 years. In the wake of the 1929 Crash--and the subsequent discovery that insiders had used their positions to skim millions from the market--dramatic reforms were enacted, including the creation of the SEC, the passage of the Glass-Steagall Act separating banks from investment houses, and the outlawing of short-selling by corporate officers.
Is the situation today as dire as it was in 1929? Of course not. But it is serious--serious enough that real reform is once again needed to restore confidence in the system. Already there has been a flood of proposals, which range from the good to the not-so-good. For instance, the New York Stock Exchange's recently announced plan to strengthen boards of directors has been widely lauded--praise, we believe, that is quite deserved (see item 5). If enacted, the NYSE reforms will help prod boards to finally act in the interest of shareholders--which, after all, is supposed to be their job. Similarly, the SEC's decision to crack down on Edison Schools sends an enormously important signal. Money that was going to pay, say, teachers' salaries was being booked by the company as revenue--even though the money never actually flowed through Edison. Believe it or not, Edison's accounting abided by Generally Accepted Accounting Principles, or GAAP. In going after Edison, the SEC was saying that simply staying within GAAP is no longer good enough--not if the spirit of the rules is being violated, as was clearly the case with Edison.
Continued at http://www.fortune.com/indexw.jhtml?channel=artcol.jhtml&doc_id=208314
past six months have
featured a parade of
corporate leaders who were
irresponsible stewards of
other people's money and
trust. They were apparently
so consumed by greed that
they never dreamed of
getting caught, ruining
companies, and shaming
themselves. In so doing,
they have created what Al
Vicere, a professor of
strategic leadership at
University's Smeal College
of Business, calls a CEO
crisis." All of which
raises the question: Why?
What is it about the
character of today's
corporate chieftains that
has led them into CEO-gate
-- which at times prompts
them to indulge in behavior
more reminiscent of fallen
TV ministers than of
FULL VERSION http://www.businessweek.com/bwdaily/dnflash/jun2002/nf20020613_9296.htm?c=bwcareersjun26&n=link1&t=email
Deloitte & Touche in the Hot Seat
"Fugitive Billions," Washington Post Editorial, June 3, 2002, Page A14 --- http://www.washingtonpost.com/wp-dyn/articles/A49512-2002Jun2.html
IN THE AFTERMATH of Enron, the tarnished auditing profession has mounted what might be called the "complexity defense." This involves frowning seriously, intoning a few befuddling sentences, then sighing that audits involve close-call judgments that reasonable experts could debate. According to this defense, it isn't fair to beat up on auditors as they wrestle with the finer points of derivatives or lease receivables -- if they make calls that are questionable, that's because the material is so difficult. Heck, it's not as though auditors stand by dumbly while something obviously bad happens, such as money being siphoned off for the boss's condo or golf course.
Really? Let's look at Adelphia Communications Corp., the nation's sixth-largest cable firm, which is due to be suspended from the Nasdaq stock exchange today. On May 24, three days after the audit lobby derailed a Senate attempt to reform the profession, Adelphia filed documents with the Securities and Exchange Commission that reveal some of the most outrageous chicanery in corporate history. The Rigas family, which controlled the company while owning just a fifth of it, treated Adelphia like a piggy bank: It used it, among other things, to pay for a private jet, personal share purchases, a movie produced by a Rigas daughter, and (yes!) a golf course and a Manhattan apartment. In all, the family helped itself to secret loans from Adelphia amounting to $3.1 billion. Even Andrew Fastow, the lead siphon man at Enron, made off with a relatively modest $45 million.
Where was Deloitte & Touche, Adelphia's auditor, whose role was to look out for the interests of the nonfamily shareholders who own four-fifths of the firm? Deloitte was apparently inert when Adelphia paid $26.5 million for timber rights on land that the family then bought for about $500,000 -- a nifty way of transferring other shareholders' money into the Rigas's coffers. Deloitte was no livelier when Adelphia made secret loans of about $130 million to support the Rigas-owned Buffalo Sabres hockey team. Deloitte didn't seem bothered when Adelphia used smoke and mirrors to hide debt off its balance sheet. In sum, the auditor stood by while shareholders' cash left through the front door and most of the side doors. There is nothing complex about this malfeasance.
When Adelphia's board belatedly demanded an explanation from its auditor, it got a revealing answer. Deloitte said, yes, it would explain -- but only on condition that its statements not be used against it. How could Deloitte have forgotten that reporting to the board (and therefore to the shareholders) is not some special favor for which reciprocal concessions may be demanded, but rather the sole reason that auditors exist? The answer is familiar. Deloitte forgot because of conflicts of interest: While auditing Adelphia, Deloitte simultaneously served as the firm's internal accountant and as auditor to other companies controlled by the Rigas family. Its real allegiance was not to the shareholders but to the family that robbed them.
It's too early to judge the repercussions of Adelphia, but the omens are not good. When audit failure helped to bring down Enron, similar failures soon emerged at other energy companies -- two of which fired their CEOs last week. Equally, when audit failure helped to bring down Global Crossing, similar failure emerged at other telecom players. Now the worry is that Adelphia may signal wider trouble in the cable industry. The fear of undiscovered booby traps is spooking the stock market: Since the start of December, when Enron filed for bankruptcy, almost all macro-economic news has been better than expected, but the S&P 500 index is down 2 percent.
Without Enron-Global Crossing-Adelphia, the stock market almost certainly would be higher. If the shares in the New York Stock Exchange were a tenth higher, for example, investors would be wealthier by about $1.5 trillion. Does anyone in government care about this? We may find out when Congress reconvenes this week. Sen. Paul Sarbanes, who sponsored the reform effort that got derailed last month, will be trying to rally his supporters. Perhaps the thought of that $1.5 trillion -- or even Adelphia's fugitive $3 billion -- will get their attention.
The above article must be juxtaposed against this earlier Washington Post article:
"Andersen Passes Peer Review Accounting Firm Cleared Despite Finding of Deficiencies," by David S. Hilzenrath, The Washington Post, January 3, 2002 --- http://www.washingtonpost.com/wp-dyn/articles/A54551-2002Jan2.html
But the review of Andersen reflected the limitations of the peer-review process, in which each of the so-called Big Five accounting firms is periodically reviewed by one of the others. Deloitte's review did not include Andersen's audits of bankrupt energy trader Enron Corp. -- or any other case in which an audit failure was alleged, Deloitte partners said yesterday in a conference call with reporters.
In its latest review, Deloitte said Andersen auditors did not always comply with requirements for communicating with their overseers on corporate boards. According to Deloitte's report, in a few instances, Andersen failed to issue a required letter in which auditors attest that they are independent from the audit client and disclose factors that might affect their independence.
In a recent letter to the American Institute of Certified Public Accountants, Andersen said it has addressed the concerns that Deloitte cited.
Deloitte and Touche released it Quality
of Earnings Report --- http://www.deloitte.com/dt/cda/doc/content/DTQEfinal(1).pdf
This is primarily intended to improve reporting to Audit Committees and Boards of Directors of Corporations
The American financial reporting system. However, recent events have shown that there is room for improve-ment. These events, coupled with increasingly complex global business structures, demand that the time for improvement in quality and integrity is now. We recognize that the current state of the financial reporting system and the profession is not perfect. Deloitte & Touche is committed to being leaders for the profession, our clients, and other companies on the journey of improvement.
Although the faith of the investing public will be restored, investors are certain to seek more information and ask more questions regarding the quality of financial reporting and a company’s financial condition. The investing public’s needs and demands regarding the quality of financial reporting and understanding a company’s financial condition have multiple aspects. These include, but certainly are not limited to, the quality of earnings, liquidity, strength of the balance sheet, and transparency of an enterprise’s financial reporting—each of which, while intertwined, is a separate, com-plex subject. Because earnings are at the forefront of the investing public’s mind, this document focuses on how audit committee members, boards, management, and other financial statement users can better understand and assess the quality of earnings.
Role of Management and the Audit Committee Relative to Quality of Earnings. Management has always had responsibility for the selection and application of accounting principles, as well as the underlying estimates and judgments used in applying such principles. Hence, management is ultimately responsible for the quality of earnings.
In contrast, the role of the audit committee has evolved over time. This evolution saw significant changes in 1999 after The Blue Ribbon Committee on Improving the Effectiveness of Corporate Audit Committees issued its report, which resulted in the implementation of various rules and standards by the stock exchanges, regulatory bodies, and standards-setting bodies. Among other things, the new rules and stan-dards require discussion among the audit committee, management, and the external auditors regarding the quality, not just the acceptability, of the entity’s accounting principles as applied in the financial statements. It is important to recognize that the quality of accounting principles is not the same as the quality of earnings, but the two are inherently linked in that the judgments used in selecting and applying such principles directly impact the quality of earnings.
. . .
Indicators of Overall Earnings Quality.
The characteristics affecting the quality of earnings provide a basis for consider-ing the individual income and expense items that comprise earnings. There are various indicators in the financial state-ments that readers can use to assess earnings on a high level. These are:
- Overall consistency of accounting policies from year to year or quarter to quarter
- Overall degree of estimation or subjectivity in determining earnings
- Trend in reserve balances
- Transparency of footnote disclosures
- Complexity of MD&A and discussion of nonrecurring, unusual transactions
- Presence of pro forma measures of earnings
- Disclosure of related-party transactions
- Ratio of net income to cash from operations
- Uncertainties and contingencies disclosed in the foot-notes and MD&A
This list is not comprehensive; depending on circumstances unique to an industry or company, there may be other indica-tors. Many industries have common measures that are widely used and followed. It is not advisable to rely on a single indica-tor to assess overall earnings quality; rather, it is appropriate to consider all indicators in the aggregate as part of the process described in the next section.
Continued at http://www.deloitte.com/dt/cda/doc/content/DTQEfinal(1).pdf
PricewaterhouseCoopers CEO Proposes New Corporate Reporting Model --- http://www.cfodirect.com/cfopublic.nsf?opendatabase&sessionId=
Sam DiPiazza, CEO of PricewaterhouseCoopers, called for creation of a new three-tier structure for corporate reporting that includes global accounting standards. The model, proposed in a speech before the National Press Club in Washington, D.C., would provide investors and stakeholders with more relevant and reliable information, and help restore the public's confidence in the capital markets. It is the first detailed blueprint for reform of accounting practices to be offered by a major firm in the wake of the collapse of Enron.
Washington, D.C., 17 JUN 2002 – Sam DiPiazza, CEO of PricewaterhouseCoopers, today called for creation of a new three-tier structure for corporate reporting that includes global accounting standards. The model, proposed in a speech before the National Press Club in Washington, D.C., is intended to provide investors and stakeholders with more relevant and reliable information, and help restore the public's confidence in the capital markets. It is the first detailed blueprint for reform of corporate reporting to be offered by a major firm in the wake of the collapse of Enron.
"Reforms must be instituted to ensure that the sacred trust of the public does not disappear, and the foundation for those reforms lies in corporate reporting," DiPiazza said. "Today I offer a vision of the future of corporate reporting based on a fresh view of the responsibilities of every participant in the corporate reporting supply chain and revised models of corporate disclosure and standards of auditing. It is the responsibility of all – the company executives, the board of directors, the auditing firm, the sell-side analysts, information distributors – to provide investors and other stakeholders with more accurate and timely information."
Three-Tier Corporate Reporting Model
To help create a new environment of trust, PricewaterhouseCoopers has proposed a Three-Tier Model of Corporate Transparency. These three tiers include:
The Three Tier model does not call for companies simply to report information in three disconnected tiers. Instead, companies would communicate to investors and others in an integrated fashion, providing a holistic view of the enterprise – its marketplace opportunities, its strategies, its value drivers, and its financial outcomes.
- A set of global generally accepted accounting principles (Global GAAP) focused on principles-based, not rules-based reporting standards.
- Standards for measuring and reporting information that are specific to respective industries and consistently applied.
- Guidelines for company-specific information including items such as strategy, plans, risk management practices, compensation policies, corporate governance, and performance measures.
Key Elements of Public Trust
Underpinning the new model, according to DiPiazza, are three key elements: transparency, accountability, and integrity.
Spirit of Transparency: Transparency means identifying and reporting to investors the information needed to make decisions, not merely satisfying minimum statutory reporting requirements.
Culture of Accountability: Just providing information is not sufficient. It must be accompanied by a commitment to accountability among participants in the Corporate Reporting Supply Chain. That requires that each of them take responsibility, for what they do.
People of Integrity: Transparency and accountability won't automatically earn the public's trust. Both are dependent on people of integrity within organizations who will "do the right thing," not only what is expedient or even simply what is permissible.
"The promise of improving future audits has been constrained by antiquated laws, rigid rules, punitive legal systems that chill innovation in corporate reporting – and also by the auditing profession's reluctance to accept a wider charter that would entail more risk," said DiPiazza. "Looking to the future, the auditing profession, with the support of standard setters and market regulators, must step forward with other members of the Corporate Reporting Supply Chain and take on greater responsibility."
According to Mr. DiPiazza, "Investors and other stakeholders, however, will more readily accept their responsibility when they know that the information on which their decisions are based is prepared, approved, and audited in a spirit of transparency."
DiPiazza explained that transparency and accountability would be enhanced not only by the three-tier approach, but also by the adoption of a new Internet-based platform for reporting and accessing data called XBRL. XBRL will play an essential role in achieving the corporate transparency embodied in the Three-Tier Model because of its ability to "tag" any individual piece of information with a precise contextual description. This will not only improve investor access to corporate information but also enhance the ability to validate the reported information in accordance with standards such as Global GAAP.
"XBRL will also dramatically increase the speed at which users can obtain information," added DiPiazza. "Stakeholders can make a request from within their analytical software and in seconds the data they want will be incorporated into their analysis. For example, immediately uncovering a company's revenue recognition policy buried in the footnotes of a 100-page annual report. By reducing the time and costs for collecting data, XBRL will also help to level the playing field for all investors and stakeholders."
Further detail regarding this new corporate reporting structure is outlined in a forthcoming book co-authored by DiPiazza and Dr. Robert Eccles – Building Public Trust: The Future of Corporate Reporting, which is being published by John Wiley & Sons, Inc. on July 12, 2002.
Click here to download the entire report --- BPTDiPiazza.pdf
From the June 21 edition of Double Entries --- http://accountingeducation.com/news/news2995.html
Title: SEC PRACTICE SECTION ACTIVELY MONITORING ANDERSEN (USA) REMAINING AUDITS Source: AICPA Country: USA Date: 18 June 2002 Contributor: Andy Lymer Web: http://www.aicpa.org
According to an AICPA Press Release yesterday; 'The verdict of guilt in the Arthur Andersen, LLP (Andersen) obstruction of justice trial is a serious condemnation of the firm. Given Andersen's decision to discontinue its audit practice on or about August 31, 2002, the Executive Committee of the AICPA's SEC Practice Section (SECPS) continues to focus on ensuring that ongoing public company audits conducted by Andersen are performed in accordance with professional standards. Two weeks ago, the SECPS Executive Committee, in coordination with Andersen and the Transition Oversight Staff (formerly the staff of the Public Oversight Board), began actively monitoring Andersen's quality control procedures for those audits in progress.
'The SECPS Executive Committee has accepted Andersen's resignation as an SECPS member firm, effective August 31, 2002. The SECPS and Andersen have agreed that: (1) until August 31 the Executive Committee will continue to monitor the quality controls employed in Andersen's public company audit practice; (2) Andersen will cooperate with the AICPA's Quality Control Inquiry Committee (QCIC) in its ongoing analysis of reported cases, including Enron; (3) Andersen will cooperate with the Professional Ethics Division in its investigation of Andersen partners and employees who may have violated the code of professional conduct; (4) Andersen partners will immediately resign from SECPS committees, and (5) effective immediately, Andersen will not become principal auditor-of-record for any new SEC client.
'The AICPA's QCIC ongoing investigation of a number of cases involving Andersen, including the Enron matter, commenced last December. QCIC cases analyze the application of professional standards and may result in referrals to the AICPA's Professional Ethics Division, which is responsible for investigating and disciplining individuals. Notwithstanding Andersen's decision to discontinue its public audit practice, the firm has agreed with the Executive Committee to cooperate with QCIC and the Professional Ethics Division to complete cases that they have opened. Further, Andersen has agreed to continue to report additional cases as they arise as well as information concerning individuals that could result in additional referrals to the Ethics Division by QCIC.
From the June 21 edition of Double Entries --- http://accountingeducation.com/news/news2969.html
Title: THE BUSINESS ROUNDTABLE COMMENTS ON NYSE PROPOSALS Source: Business Roundtable Country: USA Date: 10 June 2002 Contributor: Frank D'Andrea Web: http://www.brtable.org/pdf...
The Business Roundtable has commented on the report by the New York Stock Exchange (NYSE) Corporate Accountability and Listing Standards Committee.
According to Franklin D. Raines, Chairman and Chief Executive Officer of Fannie Mae, and Chairman of The Business Roundtable's Corporate Governance Task Force, "The Report contains some good ideas that will help restore investor confidence in our markets. We are still reviewing the details of the proposals, and plan to work with the Exchange and its Committees and Board, to ensure that the proposals improve corporate governance."
On May 14, BRT released a series of recommendations to strengthen corporate governance in the wake of the Enron bankruptcy. The proposals include:
- Ensure that a substantial majority of the board of directors comprises independent directors both in fact and appearance;
- Require that only independent directors may sit on the board committees that oversee the three functions central to effective governance - audit, corporate governance and compensation;
- Require stockholder approval of stock options and restricted stock plans in which directors or executive officers participate;
- Create and publish corporate governance principles so that everyone from employees to potential investors understand the rules under which the company is operating;
- Provide employees with a way to alert management and the board to potential misconduct without fear of retribution;
- Ensure prompt disclosure of significant developments;
- Establish a management compensation structure that directly links the interests of management to the long-term interests of stockholders, which includes a mix of long- and short-term incentives;
- Require the audit committee to recommend the selection and tenure of the outside auditor and consider what policies should be adopted by the company with respect to changing the outside auditor, rotating the audit engagement team personnel or limiting the hiring of such personnel.
The documents relating to BRT's "Principles of Corporate Governance" are available on the organization's Web site. The report can be downloaded at www.brtable.org/pdf/704.pdf (pdf).
"The Revenue Games People (Like Enron) Play," Carol J Loomis, Fortune, April 15, 2002 --- http://www.fortune.com/indexw.jhtml?channel=artcol.jhtml&doc_id=207024
Of all the accounting weirdness around--could anyone ever have dreamed that accounting would vie with pedophilia as front-page news?--the aspect that has most fundamentally affected the FORTUNE 500 is the handling of what are called "energy trading contracts."
These things, almost single-handedly, made Enron one of the largest companies on our list--No. 7 in 2000 and No. 5 this year. These contracts have also caused many other energy and utility companies to show big to enormous increases in revenues from what they originally reported for 2000. A company many of our readers have most likely never heard of, Idacorp (formerly known as Idaho Power), leaped onto the list thanks to a 454% revenue increase; at American Electric Power revenues rose 347%; Calpine's jumped 233%. Another company, Mirant, which was spun out of Southern Co., is popping up on the list for the first time with an astonishing $31.5 billion in revenues--more, for example, than Dell or Motorola. All these figures were blessed by the authorities that FORTUNE has always relied on: companies' outside auditors and their watchdog, the Securities and Exchange Commission
We will explain these wacky revenue leaps. But first, an explanation as to why the Greatest Leaper of them all, Enron, is fifth on our 2001 list. To begin with, Enron, going by the restated financials it issued for the first nine months of last year, inarguably was a huge company. In fact, its $139 billion in revenues for nine months exceeded General Electric's full-year revenues of $125 billion.
Then, on Dec. 2, Enron went into bankruptcy (a fact that doesn't disqualify it from the 500 list), and it has yet to report fourth-quarter results. The missing quarter, in which we knew revenues had fallen dramatically, gave us a problem. So we took a stab at estimating full-year revenues and concluded they might reach a maximum of $160 billion. But rather than create a precedent of using revenue estimates on the FORTUNE 500 list, we decided to rank Enron based on its nine-months revenues of $139 billion--and that figure is what makes it fifth on our list, behind Wal-Mart, Exxon Mobil, GM, and Ford. (Had we used the $160 billion estimate, Enron would still have trailed Ford.) Given the questions that hang over Enron's profits, assets, and stockholders' equity, we didn't think we could report plausible figures for those categories.
So how valid are Enron's mountainous revenues? To answer that you need to understand a bit about energy trading contracts. These are commodity contracts, mainly for natural gas, oil, and electricity, and they are entered into by traders hoping to earn a profit on future shifts in market prices. The traders are not only energy companies but also--and this is a fact that's important to our revenue tale--Wall Street firms such as UBS Warburg, Salomon Smith Barney, J.P. Morgan Chase, and Morgan Stanley.
So let's imagine a contract for $1 million of natural gas (we'll skip the btu details), to be delivered six months from now. If a Wall Street firm sold this contract, nothing called "revenues" would ever be created. Instead, the firm would periodically mark the contract to market--that is, measure the profit or loss earned on the contract--and, when time came to report, put that dollar result into an income statement item called "trading gains and losses" (which is considered revenue on the FORTUNE 500). In accounting parlance, this is known as reporting "net."
But in the 1990s many energy and utility companies, with Enron apparently acting as Pied Piper, began to report a lot of contracts "gross," meaning that in our example they put the $1 million value of that contract directly into revenues. They concurrently offset those revenues with a roughly equal cost for the gas, and thereafter measure profit and loss just like the Wall Street firms. All other things being equal, they end up with an identical profit to what the Wall Street firm makes. But there's obviously a monster difference in reported revenues--zero dollars in the Wall Street case, $1 million in the energy case.
Stoking the Furnaces
Big volume in energy trading contracts, and a hot method of accounting for their revenues, have put the four biggest energy companies--Enron, American Electric Power, Duke, and El Paso--into the upper reaches of the FORTUNE 500.
FORTUNE 500 rank
American Electric Power
FORTUNE 500 Median
Question: What is an revenue "roundtrip?"
"You Read It Here First (Sort Of)," by Carol J. Loomis, Fortune, June 2002, Page 130 --- http://www.fortune.com/indexw.jhtml?channel=artcol.jhtml&doc_id=208134
We didn't see ourselves as clairvoyant. But in a FORTUNE 500 article ( April 15) about revenue games, we discussed energy-trading abuses we thought possible. And--guess what?--we and the world have since learned that such mischief was going on even as we wrote.
The game here arises from the accounting for energy-trading contracts. Wall Street firms doing these always report "net," recording any profit realized as revenue. But most energy companies (having copied Enron) report many trades "gross," recording their total dollar amount as revenue. We saw a danger there: "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."
Well, on May 9, the Wall Street Journal reported that Dynegy had done two huge roundtrip, no-profit trades with CMS Energy last fall (though Dynegy says revenues from these were "eliminated" from its 2001 financial reports). And on May 13, Reliant Resources revealed that it had, over three years, done roundtrip trades with CMS and three other parties for no other purpose than to show big volume. The next confessor, of course, was CMS itself.
After that, the disclosures were more convoluted. Duke Energy said it had done some roundtrip trades for legitimate business purposes (though the purposes seemed rather dubious to us) but "not to inflate revenues or trading volume." The nub here is that the trades did inflate, whether that was the purpose or not. Mirant, speaking still more carefully, denied doing "any simultaneous buy and sell trades with counterparties for the purpose of inflating its trading volumes or revenues." So were there simultaneous trades done for other purposes? After much equivocation, a Mirant spokesman said no.
Meanwhile, Reliant says it may dump "gross" reporting for "net." The Financial Accounting Standards Board could weigh in on that issue as well. It has a new revenue-recognition project aimed partly at eliminating "inconsistencies" in practices--which certainly exist right here in Energy City.
No professional wants to be deceived, but sometimes it just happens. Criminals lie to their lawyers, students cheat on tests given by their teachers, and clients alter financial statements prepared by their CPAs. http://www.accountingweb.com/item/83462
The New York Stock Exchange has drafted proposed rules and recommendations designed to guide the markets past a crisis of confidence that NYSE Chairman Richard Grasso calls "moments of madness" in the days following the Enron collapse. Some of the NYSE's points have already proven controversial within the business community, but Securities and Exchange Commission Chairman Harvey Pitt hails them as "a significant step in addressing major concerns raised by the investing public." http://www.accountingweb.com/item/82995
Bob Jensen's threads on the Enron/Andersen scandals are at http://www.trinity.edu/rjensen/fraud.htm
Bob Jensen's SPE threads are at http://www.trinity.edu/rjensen//theory/00overview/speOverview.htm
Bob Jensen's threads on accounting theory are at http://www.trinity.edu/rjensen/theory.htm
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: firstname.lastname@example.org