Accounting Scandal Updates and Other Fraud on June 30, 2004
Bob Jensen at Trinity University


Bob Jensen's Main Fraud Document --- 

Other Documents

Many of the scandals are documented at 

Resources to prevent and discover fraud from the Association of Fraud Examiners --- 

Self-study training for a career in fraud examination --- 

Source for United Kingdom reporting on financial scandals and other news --- 

Updates on the leading books on the business and accounting scandals --- 

I love Infectious Greed by Frank Partnoy --- 


Accounting Education Shares Some of the Blame --- 

In all, four months in a minimum-security prison seemed like a small price to pay for the millions of dollars Mozer made. In 2001, Mozer was enjoying his wealth--relaxing, and raising his eight-year-old daughter. He spent much of his time managing his own money and playing golf. Mozer's treatment raised an interesting question: what would most people have done in his situation--assuming they knew in advance they would be caught and spend four months in a low-security prison--if they also knew that, afterward, they would retire as a multimillionaire, all before their fortieth birthday? Compared to Mozer, his supervisors received mere slaps on the wrist. Gutfreund, Strauss, and Meriweather paid fines of $100,000, $75,000, and $50,000, respectively--just a few days' pay, at their salaries.
Frank Partnoy, Infectious Greed (Henry Holt and Company, 2004, Page 109) with respect to derivatives fraud at Salomon.
Bob Jensen's threads on slaps on the wrist for white collar crime are at "White Collar Crime Pays Big Even If You Get Caught" at 

According to a joint survey by PricewaterhouseCoopers and the Economist Intelligence Unit, financial institutions have equated good corporate governance with meeting the demands of regulators rather than improving the quality of management. PwC suggests how to comply and improve in order to reap the potential strategic advantages of improved governance.
SmartPros, April 7, 2004 --- 

"The conviction rate in these cases is 85 percent in federal court," said Ira Lee Sorkin, a New York defense lawyer and former prosecutor. "It's not hard to win these cases."  Last week, Jamie Olis, a former midlevel executive at Dynegy, a Houston energy company, was sentenced to more than 24 years in prison for his role in accounting fraud at the company. The sentence was one of the most severe imposed in a white-collar fraud case, prosecutors and defense lawyers said.
Alex Berenson, "Despite 2 Mistrials, Prosecutors Rack Up White-Collar Victories," The New York Times, April 4, 2004 --- 

The Pentagon's Inspector General found that proper accounting procedures weren't followed (by Boeing) in negotiating a $1.32 billion contract between Boeing and the Air Force.
J. Lynn Lunsford, "Air Force Criticized by Pentagon Over $1.32 Billion Boeing Deal," The Wall Street Journal, April 16, 2004 ---,,SB108208168346084728,00.html?mod=home_whats_news_us 

A U.S. Department of Labor (DOL) administrative law judge recently issued what is believed to be the first ruling on whistleblower protections under The Sarbanes-Oxley Act. The DOL ruled that a bank's former CFO was unlawfully terminated after protesting suspected insider trading.
FERF Newsletter on April 6, 2004 
Bob Jensen's threads on whistle blowing are at 

In cautionary tales told while on probation, Karen Bond and Walt Pavlo have advice for those with assets: It pays to be constantly vigilant of financial caretakers and corporate executives.
Aissatour Sidme (See below)

The economic downturn, the default and the currency conversion all combined to leave Argentina's lenders on the hook for billions of dollars. Citigroup was among them. In the fourth quarter of 2001 and the first quarter of 2002, the bank took more than $1.2 billion in pretax charges for bad loans and other losses in Argentina. The bank, the world's largest, ultimately wrote off about $2 billion in soured Argentine loans and investments.
Timothy L. O'Brien (See below)

Pays to go bankrupt!
MCI predicted a net loss for this year and reported a massive $22.2 billion profit for 2003 as a result of accounting adjustments related to the bankruptcy.
Shawn Young, The Wall Street Journal, April 30, 2004, Page B3 ---,,SB108327600038897861,00.html?mod=technology_main_whats_news 

The New York State Attorney General's office has doubled the amount of money it won in fines and restitution last year, thanks to a number of multimillion-dollar settlements with firms on Wall Street. 
AccountingWEB, April 13, 2004 --- 

Quattrone was found guilty after a retrial on charges that he interfered with a U.S. investigation in late 2000. The verdict, after less than a day of deliberations, was a comeback victory for the government's campaign against corporate abuses.
Randall Smith, The Wall Street Journal, May 4, 2004 ---,,SB108360692902400374,00.html?mod=home_whats_news_us 

Computer Associates International Inc. fired nine employees yesterday for involvement in a widespread accounting fraud, bringing the total number forced out to 14.
Charles Forelle and Joann S. Lublin, "Will CA's Kumar Survive Scandal Or Lose His Job?" The Wall Street Journal, April 20, 2004 ---,,SB108239189677386678,00.html?mod=technology_main_whats_news 

Joyti De-Laurey, a former personal assistant to ex-Goldman Sachs star telecom banker Scott Mead, was found guilty of stealing about $7.7 million from Mead and another Goldman banker and his wife.
Anita Raghaven, "Secretary Found Guilty In Goldman Case in U.K.," The Wall Street Journal, April 20, 2004 ---,,SB108246140634287677,00.html?mod=home_whats_news_us 

Three former employees of Duke Energy Corp. were arrested after a federal grand jury indictment was unsealed in Houston that accused the trio of 18 counts of racketeering and defrauding their onetime employer through a false energy-trading and accounting scheme.
Rebecca Smith, "Former Employees Of Duke Charged Over Wash Trades," The Wall Street Journal, April 22, 2004 ---,,SB108257549068489537,00.html?mod=home%5Fwhats%5Fnews%5Fus 

Mr. Brown said the dispute with the auditor about disclosing the borrowings occurred in March 2001 as the company and Deloitte were preparing Adelphia's 2000 annual report. Deloitte issued a clean audit opinion in that report. He said he was able to convince the Deloitte auditor not to disclose the total amount the Rigases had borrowed, but to disclose only the amount the Rigases could borrow under the arrangement. "I didn't want the public to know how much the Rigases had borrowed because I thought there would be significant negative ramifications," Mr. Brown said. He testified that Timothy Rigas told him "we should give up on other points if we have to, but that's the last point we want to give up on with the auditors."
Christine Nuzum (see below)

For an account of how badly a whistle blower on accounting fraud at Duke Energy was treated, see "Duke Whistle-Blower Goes Public," by Ted Reed,  The Charlotte Observer, August 19, 2002 --- 

Paychecks are now more politically correct, but CEO wallets won't shrink overnight. See which executives nabbed the juiciest pay bonanzas last year.
Bob Jensen's threads on corporate governance frauds are at 
"Here Comes Politically Correct Pay," The Wall Street Journal, April 12, 2004 ---,,2_1081,00.html?mod=home_in_depth_reports 

Welcome to the new world of politically correct pay, where directors increasingly scrutinize their leader's compensation through the eyes of irate shareholders, workers and regulators. That already means some big changes are in the works. But nobody should weep for the CEO just yet: Even the most sweeping moves won't shrink chief executives' bulging wallets overnight.

Message to Valero on April 17, 2004
Hi Pepper,

I request that you print this message for all participants of the workshop that I will present at Valero.

Of all the many documents and books that I have read about derivative financial instruments, the most important have been the books and documents written by Frank Partnoy. Some of his books are commented upon at 

The single most important document is his Senate Testimony. More than any other single thing that I've ever read about the Enron disaster, this testimony explains what happened at Enron and what danger lurks in the entire world from continued unregulated OTC markets in derivatives. I think this document should be required reading for every business and economics student in the world. Perhaps it should be required reading for every student in the world. Among other things it says a great deal about human greed and behavior that pump up the bubble of excesses in government and private enterprise that destroy the efficiency and effectiveness of what would otherwise be the best economic system ever designed.

It would be neat if you could print his entire testimony as advance reading (15 pages) for the audience ---  
Please print my message as well since it lists some of his other writings.

The CD I sent you contains only a miniscule fraction of the helper documents and videos on derivatives and derivatives accounting that I have linked at 

I appreciate this opportunity to meet with Valero specialists in derivatives and derivatives accounting.



Bob Jensen's threads on Enron are at 

Bob Jensen's threads on Derivative Financial Instruments Fraud are at 

Also note 

How Enron Used SPEs and Derivatives Jointly is Explained at


Bob Jensen’s threads on derivatives accounting are at

In the end, derivatives are like antibiotics.  It's dangerous to live with them, but the world is better off because of them.  The same can be said about FAS 133 and its many implementation guides and amendments.  Booking derivatives at fair value is dangerous, but the economy would be worse off without it.  What we have to do is to strive night and day to improve upon reporting of value and risk in a world that relies more and more on derivative financial instruments to manage risks.

"Bank One Settles Allegations Over Improper Fund Trading," The Wall Street Journal, June 29, 2004 ---,,SB108854358741950719,00.html?mod=us_business_whats_news 

A unit of Bank One Corp. agreed to a $90 million settlement of allegations by the New York attorney general's office and the Securities and Exchange Commission that it allowed a hedge fund to make improper mutual-fund trades.

The settlement Tuesday by Banc One Investment Advisors Corp., which comes days before the Chicago bank merges with J.P. Morgan Chase & Co., makes the Bank One unit the last to settle charges related to market-timing abuses of the original four firms mentioned in New York Attorney General Eliot Spitzer's September complaint against hedge fund Canary Capital Partners.

Banc One Advisors said in a news release that it will return $50 million -- $40 million in a civil fine and $10 million in disgorgement -- to eligible shareholders as part of the settlement. The firm also agreed to reduce fees by $40 million over five years.

"Soon after we first learned of these investigations, we committed to cooperate with regulators, make restitution to shareholders, and review and change our policies," David J. Kundert, chief executive of Banc One Investment Advisors, said in a prepared statement, adding that procedures are now in place to "prevent a recurrence of similar issues in the future."

Mark Beeson, the former chief executive of the Banc One fund unit, was ordered to pay a civil fine of $100,000. He is also barred from the fund industry for two years and prohibited from acting as a director or officer for a mutual fund or investment adviser for three years, the SEC said in a news release.

Stephen Cutler, director of the SEC's division of enforcement, said Mr. Beeson "blatantly disregarded the well-being" of long-term fund shareholders by allowing Canary Capital to market time the One Group family of funds, and by providing Canary confidential information on fund portfolio holdings.

The mutual-fund scandal, in which fund companies profited by allowing a few sophisticated traders to buy and sell shares in ways that hurt the returns of regular investors, has implicated as many as 20 fund companies and involved millions of investors. So far, mutual-fund companies have agreed to settlements totaling more than $2 billion, with most of that money pegged to be returned to investors.

The scandal encompasses both market timing -- rapid buying and selling of fund shares to exploit inefficiencies in fund-share pricing -- and late trading, which is illegal. Late traders buy or sell fund shares after the market's 4 p.m. close, while using the price determined at the close. Market timing, while not illegal, often violates a fund's stated rules.

Bob Jensen's threads on the mutual funds scandals are at

"Two Siebel Executives Had Loose Lips, SEC Says:  Company Is the First One Charged Twice for Violating The "Fair Disclosure" Rule," by David Bank and Debora Solomon, The Wall Street Journal, June 30, 2004, Page C3 ---,,SB108852785824650351,00.html?mod=technology_main_whats_news 

Executives at Siebel Systems Inc. haven't learned when to keep quiet, the Securities and Exchange Commission says.

The SEC yesterday said Siebel and two of its senior executives violated the commission's fair-disclosure rules last year when the executives privately gave institutional investors a rosier picture of the company's prospects than had been disclosed publicly only days earlier, contributing to a one-day, 8% jump in Siebel shares.

Siebel is the first company to be charged twice with violating the SEC's Regulation FD (for "fair disclosure"), which was adopted in October 2000 to put small and large investors on an even playing field for access to corporate information. In November 2002, the San Mateo, Calif., maker of business software agreed to pay a $250,000 civil penalty, without admitting wrongdoing, after the SEC questioned remarks made by chairman and founder Tom Siebel at an investor conference.

Yesterday the SEC also charged Siebel with violating an agreement, stemming from the earlier violation, to adhere to the fair-disclosure rule. In another first, the agency charged Siebel with violating an SEC rule that requires companies to maintain procedures to ensure that information is disclosed to all investors in a timely fashion.

Because of the repeat nature of the alleged violations, the SEC asked a federal judge in New York to issue a permanent injunction barring Siebel from future violations. The SEC also asked for an injunction restraining the two executives from "aiding and abetting" violations of the rules. The agency also is seeking fines against Siebel and the two executives, but didn't specify the size of the possible fines.

The detailed complaint shows how some companies allegedly continue to try to bolster relationships with key investors by offering more information than they share with the broader public. The fair-disclosure rules, adopted in the wake of the tech-stock bubble, are intended to help small investors by combating a once-common practice whereby large investors or analysts would get market-moving information ahead of the public.

A Siebel spokesman declined to comment on the new charges.

The charges are the latest in a series of controversies that have swirled around Siebel and its brash founder, who stepped aside as chief executive earlier this year. In January 2003, Mr. Siebel canceled all stock options he had received since 1998 after criticism by some large investors about excessive executive compensation.

The latest complaint doesn't name Mr. Siebel personally. But the SEC claims Kenneth Goldman, Siebel's chief financial officer, and Mark Hanson, the company's former director of investor relations and now senior vice president for corporate development, in April 2003 selectively disclosed financial information in one-on-one meetings with institutional investors.

Early that month, Siebel said it wouldn't meet previous forecasts for first-quarter earnings. The company repeated a gloomy outlook in a conference call following the release of its earnings on April 23. Five days later, Mr. Siebel expounded on the pessimism in a speech at an investor conference. "With war, with famine, with disease, I mean it's like the apocalypse out there," the SEC quotes Mr. Siebel as saying.

Then, on April 30, according to the complaint, Messrs. Goldman and Hanson met with fund managers at Alliance Capital Management, a family of mutual and hedge funds, and attended a dinner hosted by Morgan Stanley. At the Alliance meeting, the SEC says, Mr. Goldman said Siebel's level of sales activity was "better," that the company had deals in its "pipeline" valued at more than $5 million, and that the pipeline was "growing."

The SEC complaint says two Alliance portfolio managers who hadn't held Siebel stock placed orders to purchase 114,200 shares immediately following the meeting, while markets were still open. A third fund manager, alerted by colleagues who had attended the meeting, by the next day had covered a short position of 108,200 shares -- a net change of 222,400 shares. The Alliance fund manager who held the short position had viewed Siebel as "kind of a small junky company," according to the SEC. An Alliance spokesman declined to comment.

According to the complaint, the two Siebel executives made similar remarks at the Morgan Stanley dinner that evening, attended by six institutional investors and Morgan Stanley employees. Early the next morning, the SEC says, Morgan Stanley sent e-mail to hundreds of individuals, detailing the "positive data points" from the dinner, including the growing pipeline. Two fund managers who attended the dinner bought Siebel shares the next morning.

That day, May 1, Siebel shares jumped 8% to $9.34, with trading volume nearly double the average daily volume for the previous 12 months, the SEC said.

As the stock rose, Jeffrey Amann, Siebel's general counsel, asked Mr. Goldman by e-mail whether additional disclosure was required. Mr. Goldman responded late that evening that he had "only reiterated exactly what was stated on the earnings call." Mr. Hanson told Mr. Amann rumors about Mr. Goldman's comments were false, the SEC says.

Continued in the article

Bob Jensen's threads on accounting fraud are at 

How can you "PUT" away your cares about clear-cut rules of accounting?

See how AOL did it in conspiracy with Goldman Sachs

It just gets deeper and deeper for Ernst & Young

With the AOL-Time Warner deal due to close in just three months, Bertelsmann needed to reduce its AOL Europe holding -- pronto. But the obvious buyer, AOL, didn't want to own more than 50% or more of the venture, either. Going above half might trigger a U.S. accounting rule that would force AOL to consolidate all the struggling unit's losses on its books when AOL was already grappling with deteriorating ad revenues and a declining stock price. Enter Goldman Sachs Group Inc. (GS ) Business Week has learned that the premier Wall Street bank agreed to buy 1% of AOL Europe -- half a percent from each parent -- for $215 million. AOL Europe, in return, agreed to a "put" contract promising Goldman that it could sell back the 1% by a specific date and at a set price. That simple transaction solved Bertelsmann's EU problem without trapping AOL in an accounting conundrum -- a perfect solution.

"Goldman's 1% Solution," by Paula Dwyer, Business Week, June 28, 2004 --- 

Goldman's 1% Solution
In 2000, it cut a questionable deal that smoothed the AOL-Time Warner merger. Will the SEC take action?

In more ways than one, the news from the European Union was bad. It was October, 2000, and the EU's executive arm, the European Commission, had just jolted America Online Inc. with a ruling that its pending acquisition of Time Warner Inc. (TWX ) could harm competition in Europe's media markets, especially the emerging online music business. The EC was concerned that AOL was a 50-50 partner with German media giant Bertelsmann in one of Europe's biggest Internet service providers, AOL Europe. Now the EC was ordering Bertelsmann to give up control over AOL Europe.

With the AOL-Time Warner deal due to close in just three months, Bertelsmann needed to reduce its AOL Europe holding -- pronto. But the obvious buyer, AOL, didn't want to own more than 50% or more of the venture, either. Going above half might trigger a U.S. accounting rule that would force AOL to consolidate all the struggling unit's losses on its books when AOL was already grappling with deteriorating ad revenues and a declining stock price.

Enter Goldman Sachs Group Inc. (GS ) Business Week has learned that the premier Wall Street bank agreed to buy 1% of AOL Europe -- half a percent from each parent -- for $215 million. AOL Europe, in return, agreed to a "put" contract promising Goldman that it could sell back the 1% by a specific date and at a set price. That simple transaction solved Bertelsmann's EU problem without trapping AOL in an accounting conundrum -- a perfect solution.


Or so it seemed at the time. But the deal also may have violated U.S. securities laws. The Securities A: Exchange Commission and the Justice Dept. have construed some deals involving promises to buy back assets at a specific time and price as share-parking arrangements designed to mislead investors. The former chief executive of AOL Europe says the Goldman deal may have kept up to $200 million in 2000 losses off of the combined AOL-Time Warner financials -- enough, he says, that Time Warner might have tried to change the terms of the $120 billion merger, since AOL wouldn't have looked as healthy. But as the deal moved toward consummation, the Goldman arrangement was never disclosed in public documents to AOL or Time Warner shareholders.

The AOL Europe transaction threatens to create problems for Goldman Sachs. But it could also prolong the legal headaches of Time Warner Inc., as the AOL-Time Warner combine is now called. For the past two years, Time Warner has been in heated negotiations with the SEC over AOL's accounting for advertising revenues (BW -- June 7). Just as the SEC is wrapping up that case -- it could warn Time Warner as early as this summer that it intends to bring civil fraud charges -- the Goldman transaction raises troubling new questions about AOL's financial dealings prior to the merger.

The SEC has not brought charges over the 1% solution, and an SEC spokesman would not comment on whether the agency is probing the deal. Time Warner spokeswoman Tricia Primrose Wallace says the company will not comment on any part of the Goldman arrangement. A lawyer for Stephen M. Case, AOL's chairman and CEO at the time of the deal, referred questions to Time Warner. Thomas Middelhoff, who was Bertelsmann's chairman at the time of the deal and negotiated the AOL Europe joint venture with Case in 1995, says through a spokesman that the sale of a 0.5% stake was "purely a financial technique" handled by others. And Lucas van Praag, a Goldman Sachs spokesman, says: "We handled this entirely appropriately. We don't believe there is anything untoward here."

Continued in the article


"University of California, Bank Sue AOL:  Lawsuit claims firm lied about finances, cost them," by Pamela Tate, The Wall Street Journal, April 15, 2003 --- 

The University of California has joined with Amalgamated Bank to file a lawsuit against AOL Time Warner Inc., claiming their stakes have lost more than $500 million in value because the media company allegedly lied about its financial condition.

The University of California, which dropped out of a federal class-action suit against AOL earlier this month, filed the complaint Monday in the Superior Court of California in Los Angeles. The university and co-plaintiff Amalgamated Bank, a New York institution that manages funds for several dozen union pension funds, are being represented by Milberg Weiss Bershad Hynes & Lerach.

The plaintiffs allege that AOL Time Warner materially misrepresented its revenue and subscriber growth after the merger of AOL and Time Warner in January 2001. In two separate restatements in October and March, AOL slashed nearly $600 million from previously reported revenue over the past two years.

The University of California and Amalgamated allege that AOL's admissions so far have been "too conservative," and that the company may have overstated results by almost $1 billion.

In a March 28 filing with the Securities and Exchange Commission, AOL Time Warner said it faces 30 shareholder lawsuits that have been centralized in the U.S. District Court for the Southern District of New York. The company said in the filing it intends to defend itself "vigorously." The lawsuit filed by the University of California and Amalgamated names several current and former AOL Time Warner executives, as well as financial-services giants Citigroup and Morgan Stanley.

Citigroup is the parent of Salomon Smith Barney, now called Smith Barney, which with Morgan Stanley allegedly reaped $135 million in advisory fees from the AOL and Time Warner merger.

Defendants include Stephen Case, who resigned as chairman in January; former Chief Executive Gerald Levin, who left the company in May; current Chairman and Chief Executive Richard Parsons; and Ted Turner, who recently stepped down as vice chairman.

The lawsuit claims they and more than two dozen other insiders sold off $779 million in stock just after the merger closed but before the accounting revelations that would cause the stock price to plummet. The suit also names AOL's auditor, Ernst & Young.

The University of California claims it lost $450 million in the value of its AOL Time Warner shares, which were converted from more than 11.3 million Time Warner shares in the merger. At the end of 2002, the value of the university's portfolio was at $49.9 billion.

Continued in the article

Bob Jensen's threads on the Ernst & Young auditing scandals are at 

"As Doctors Write Prescriptions, Drug Company Writes a Check," by Gardner Harris, The New York Times, June 27, 2004 --- 

The check for $10,000 arrived in the mail unsolicited. The doctor who received it from the drug maker Schering-Plough said it was made out to him personally in exchange for an attached "consulting" agreement that required nothing other than his commitment to prescribe the company's medicines. Two other physicians said in separate interviews that they, too, received checks unbidden from Schering-Plough, one of the world's biggest drug companies.

"I threw mine away," said the first doctor, who spoke on the condition of anonymity because of concern about being drawn into a federal inquiry into the matter.

Those checks and others, some of them said to be for six-figure sums, are under investigation by federal prosecutors in Boston as part of a broad government crackdown on the drug industry's marketing tactics. Just about every big global drug company — including Johnson & Johnson, Wyeth and Bristol-Myers Squibb — has disclosed in securities filings that it has received a federal subpoena, and most are juggling subpoenas stemming from several investigations.

The details of the Schering-Plough tactics, gleaned from interviews with 20 doctors, as well as industry executives and people close to the investigation, shed light on the shadowy system of financial lures that pharmaceutical companies have used to persuade physicians to favor their drugs.

Schering-Plough's tactics, these people said, included paying doctors large sums to prescribe its drug for hepatitis C and to take part in company-sponsored clinical trials that were little more than thinly disguised marketing efforts that required little effort on the doctors' part. Doctors who demonstrated disloyalty by testing other company's drugs, or even talking favorably about them, risked being barred from the Schering-Plough money stream.

Continued in the article

"Crimes of Others Wrecked Enron, Ex-Chief Says," by Kurt Eichenwald, The New York Times, June 27, 2004 --- 

As Mr. Lay describes it, the Enron collapse was the outgrowth of the wrong-headed and criminal acts of the company's finance organization, and specifically its chief financial officer, Andrew S. Fastow. He says that both he and the board were misled by Mr. Fastow about the activities and true nature of a series of off-the-books partnerships that played the decisive role in the company's collapse.

Yet, Mr. Lay still argues that some of the company's most controversial decisions — including some that set up financial conflicts of interest for Mr. Fastow that could well be unprecedented in corporate America — were made for good reasons, and can be seen as mistakes only in hindsight.

The interview was conducted in Mr. Lay's office in downtown Houston. There, a picture window frames the old Enron skyscraper across town, a sight he said he rarely contemplates during his days working as a consultant for two start-up companies.

The years since the Enron collapse have transformed Mr. Lay. The changes in his financial status are stunning. At the beginning of 2001, Mr. Lay said, he had a net worth in excess of $400 million — almost all of it in Enron stock. Today, he says his worth is below $20 million, and his total available cash not earmarked for legal fees or repayment of debt is less than $1 million.

But the changes amount to more than just money. A man once celebrated in business and political circles, today he is widely vilified as bearing significant responsibility for Enron's downfall, a debacle that cost thousands of employees their jobs, millions of investors their savings, and, for a time, forced a nation to question the capital markets system. He is often portrayed as a man who bailed out of his company as it was sinking, selling millions of shares even while telling investors and employees that he believed in the company's future.

It is a portrait, he insists, that disregards the realities of Enron's last months, a time in which he describes himself as first working hard to improve the company, then struggling desperately to keep it afloat.

A Reversal of Fortune

Now, according to witnesses who have testified before the grand jury and other people involved in the investigation, prosecutors are focusing almost exclusively on Mr. Lay's actions and statements in the months preceding bankruptcy, in an effort to determine if he deceived investors about the true state of Enron before its demise even as he was selling his own stock.

However, a review of Mr. Lay's financial and trading data shows that the facts are much murkier than is generally believed, with the stock sales being forced by lenders as he took numerous actions that are consistent with someone trying to minimize his sales.

To date, numerous executives who worked for or advised Enron have pleaded guilty to crimes or been charged with wrongdoing. Virtually the entire senior management has faced legal proceedings: its treasurer, chief financial officer, primary outside accountant, corporate secretary and even a division head have all pleaded guilty to crimes. Others, including Jeffrey K. Skilling, another former chief executive, and Richard A. Causey, the former chief accounting officer, have been charged with fraud.

Mr. Lay himself has remained under investigation that entire time, and - at what he said was his legal team's insistence - invoked his Fifth Amendment right against self-incrimination in testifying before Congress.

Ken Lay's secret recipes for legally looting $184,494.426 from the corporation you manage --- 


"Spitzer Inquiry Expands to Employee-Benefit Insurers," by Joseph B. Treaster, The New York Times, June 12, 2004 --- 

Three big insurance companies, Aetna, Cigna and MetLife, said yesterday that they had received subpoenas from the New York attorney general as an investigation widened into the field of employee benefits - health, disability and group life insurance.

Hartford, which operates a substantial business in group life and disability insurance as well as in commercial and personal lines of insurance, said late Thursday that it, too, had received a subpoena.

Until now, the insurance investigations by the attorney general, Eliot Spitzer, have centered on potential conflicts of interest among commercial insurance brokers and suspected improper sales and trading of variable annuities, which are a combination of insurance and mutual funds.

Investigators have been concerned that payments from insurance companies to the brokers for exceeding sales goals and keeping down claims costs may undermine the brokers' loyalty to their customers - the American corporations that pay them fees and commissions to arrange coverage.

Industry executives said similar fees, often referred to as contingency payments, were widely paid to brokers and consultants by the employee benefits companies.

"It's no surprise that Mr. Spitzer is pursuing these contingency payments in the employee benefits area," said Terry Havens, the chief executive of Havensure, a small employee benefits consulting firm in Cincinnati. "Employers will likely be surprised to find out that their intermediaries - brokers and consultants - are negotiating financial agreements for themselves that raise the cost of corporate insurance."

None of the employee benefits insurers would discuss the investigations, and a spokesman for Mr. Spitzer did not return a call.

Several insurance brokers disclosed in late April that they had received subpoenas from Mr. Spitzer, including Marsh and Aon, the two largest in the world, and Willis Group Holdings. In mid-May, the Chubb Group, a leader in commercial insurance, said that it, too, had received a subpoena for documents dealing with compensation to brokers. Hartford said in late May that it had received instructions from the New York Department of Insurance not to destroy any documents related to its dealings with brokers. The brokers have also refused to discuss the investigations.

Industry executives said that most of the midsize and smaller companies in the country bought health insurance and other employee benefits through the big insurance brokers. But many of the biggest corporations rely, instead, on consulting firms that specialize in employee benefits and often work for negotiated fees, they said.

Executives said they thought that the consultants often received payments on both ends of transactions just as the brokers have acknowledged they do. But so far none of the consulting firms have reported receiving subpoenas.

Tom Beauregard, a senior executive at Hewitt Associates, one of the nation's largest consultants on employee benefits, said that his firm received payments exclusively from its clients except in cases where the client negotiated for an insurance company to share the costs of the consultant. When clients ask for those kinds of payments, he said, they are fully disclosed and included in estimates of all companies bidding for the coverage.

The question of disclosure has been at the heart of Mr. Spitzer's investigations of the brokers so far. The brokers often report on Web sites and in regulatory documents that they receive compensation from the insurance companies. But the corporate insurance buyers, known as risk managers, say the brokers do not routinely disclose the details of the payments.

Risk managers - who often feel dependent on brokers to get coverage, which since the Sept. 11, 2001, attacks has been costly and scarce - say they do not press for details. But even when the risk managers raise questions, some of them say, the brokers can be evasive.

Joe Conway, a spokesman for Towers Perrin, another big consultant on employee benefits, said that compensation agreements at his firm were reached in advance by clients and that the full amount of the compensation was disclosed.

Mr. Havens, who has been an employee benefits consultant for 25 years, said that in addition to bonuses for exceeding sales goals, some brokers and consultants receive extra payments from insurers for the many employees who buy life insurance or disability insurance to supplement the coverage provided by their companies. The cost of these payments, which often average $10 to $15 for each employee, are passed on directly to the employees, he said, increasing the price of the coverage they buy.

In the employee benefits field, Mr. Havens said, the sales bonuses and the extra payments for individual employees are in many cases done without the knowledge of the employers or the employees.

"The employers and the employees don't know the payments are in there," Mr. Havens said. "At the initiative of the brokers, the insurers provide a quote with the costs of these payment included."

Mr. Havens said his practice was to report to clients all payments he receives from all sources. But he said he had lost business to some brokers and consultants who, as a result of hidden payments from insurers, were willing to charge clients less for their services.

"Carriers have complained to me that they have to make these payments," Mr. Havens said. "They don't think they are appropriate. But if they don't pay, they don't get to play in the game. They don't get the business."

Brokers and consultants began demanding payments from the insurance companies about 10 years ago when they began to receive complaints from clients that their fees and commissions were too high, Mr. Havens said. While the amount that consultants and brokers received stayed at 1 percent to 5 percent of the premium, Mr. Havens said, the visible portion that employers paid to them declined.


Bob Jensen's threads on mutual fund and insurance company scandals are at 

Scam o Rama --- 

The letters posted here illustrate attempts at ADVANCE FEE FRAUD. The sender claims to be a bureaucrat, banker or royal toadie, who wants to cut you, and only you, in on the financial deal of a lifetime.

In plain English, the writer claims to be in a position to skim public accounts. Hint: There is no money to be laundered - except yours. Palms must be greased. They ask for money with which to do the greasing. A few K here, a few K there... eventually you get wise, and retire to lick your wounds. Dead military officer, dead farmer, dead bank customer, reformed murderer, imaginary request for bid, lotto prize, different countries... same scam.

Setting aside the writer's attempt to rob you and (going through the mental contortions necessary to take the letter at face value) to steal from his own country, the letters are funny. Read them out loud at parties and see. The 100+ letters below introduce the literary genre of the Lads from Lagos. Some people write the scammers back. See right column.

Most readers say "what an obvious scam!".
Some say "I was almost fooled till I saw this site."
A handful say "couldn't mine be 'real'?"
Stay safe out there!

1    When not playing on your generosity or naivete, the Lads are asking you to steal. There is nothing to be stolen, except from you.
2     Nothing here should be taken as a criticism of any nation, nor do we suggest that there are no scam artists in other countries. There sure are.
3     So why "Lads from Lagos" ? Because most of these e-mails come from there. It's just like that. Africans hate getting them too.


You never forget your first 125.
Below each letter is a list of them all.

Request for Urgent Business Relationship
Son of Urgent Business Relationship
Urgent Business Execution
Trust Fund for Alms and Ammunition
We did over-inflate the contracts
My brother Maj. Hamza El-Mustapha and his mistress in Lebanon
Confidentiality is our watchword, mutual trust is our beacon
I was a moslem until a 18months ago when the master Jesus met me
I am only trying my best not to be noticed by my government
Ein Ausländer, Verstorbene Ingenieur Johnson Creek
Mrs. Abacha gets a PhD


SARCASTIC FAQ (updated mar 9 2004)

Bob Jensen's threads on scams and scam protections are at 

What's "affinity fraud?"

Answer:  See below

A key fund-raiser for Harvard University used his connection to the school to defraud benefactors out of millions of dollars, showing how sophisticated professional investors can be just as vulnerable as amateurs.

"Harvard Parents Got a Hard Lesson In Investing Perils:  A Key Fund-Raiser for School Is Convicted of Bilking Wealthy Donors, Alumni." by Randall Smith, The Wall Street Journal, June 11, 2004, Page A1 ---,,SB108690562744434417,00.html?mod=home_whats_news_us 

Karen Fleiss had good reason to trust Gregory Earls.

Both had children at Harvard College and they knew each other as donors to the Harvard Parents Fund, which Mr. Earls headed for a time with billionaire Robert Bass. Mr. Earls was a deal maker with a penchant for high-risk investments; Ms. Fleiss was a hedge-fund manager.

So when he asked her to invest in one of his companies in 1998 -- and intimated that Mr. Bass might, too -- she opened her hedge fund's checkbook, eventually putting almost $1.8 million into the venture.

"He had a Southern accent and a big smile, and he would say, 'Karen, I have a deal for you,' " she recalls. "By the time he was finished, it sounded like the deal of a lifetime."

It wasn't. When she cashed out, all she had to show for her investment was $50,000. Ms. Fleiss was one of three wealthy Harvard parents and alumni who recently testified about being bilked by Mr. Earls. The authorities say he stole much of the money they invested with him, siphoning off cash as he passed it through another company he controlled. In the ledgers, the skimmed funds were camouflaged as legal, management or accounting fees.

All told, prosecutors say, Mr. Earls defrauded more than 100 investors of $13.8 million. They say Mr. Earls diverted $1.2 million to an education trust fund for his own children, and $4.3 million more to other personal accounts.

The Harvard connection and other fund-raising activities gave Mr. Earls "access to a pool of potential investors who were very wealthy, and he knew how to talk those people into investing with him," prosecutor William Stellmach said at the trial.

In April, Mr. Earls was convicted of 22 counts of fraud in Manhattan federal court after one investor took his suspicions to prosecutors. In court, Mr. Earls acknowledged moving investors' money to various accounts he controlled -- which he attributed to "sloppy business practices" -- but denied stealing.

His lawyer, Barry Coburn, said in court that Mr. Earls couldn't have had criminal intent to steal because he kept records of the amounts diverted. The investors "lost their money because the Internet bubble expanded and expanded and popped," Mr. Coburn argued. They didn't have "some kind of money-back guarantee."

Mr. Coburn says his client declines to comment on the details of his case. "Mr. Earls has been convicted by a jury," Mr. Coburn says. "It would not be appropriate in my view for us to respond to particular factual allegations in this context given that Mr. Earls is facing sentencing."

As described by prosecutors, Mr. Earls's scam appears to be a variation of "affinity fraud," in which victims are lulled into dropping their guard by mutual ties to the same religious organization or ethnic group. Mr. Earls cultivated important contacts through his work for the Harvard Parents Fund and the Boys & Girls Clubs of Greater Washington, D.C. -- and used data supplied by Harvard to assess likely investors.

The case shows that sophisticated professional investors can be just as vulnerable as amateurs. Much of the money Mr. Earls stole came from a handful of wealthy Harvard benefactors, including a former aide to junk-bond impresario Michael Milken. Even Harvard found itself short-changed. Mr. Earls reneged on three separate pledges totaling $275,000 that he made while he headed the parents fund, a school official testified at his trial.

Mr. Earls, 59 years old, grew up in Bluefield, W.Va., and attended the University of Virginia. In the 1970s, after stints as a gym teacher, mutual-fund salesman and stockbroker, he recruited others to invest with him in projects including movies, theaters, apartments and microwave-oven retailers. The 1980s saw him organizing investment groups that bought stakes in numerous enterprises.

In the mid-1990s, Harvard's development office took notice of Mr. Earls as a potentially productive fund-raiser for the Harvard Parents Fund. He was a big donor to the school, and three of his four children eventually enrolled there. His lawyer says in an interview that recruiting investors wasn't the principal motive for his unpaid volunteer work.

Harvard fund-raising officials are angry about what happened. "The fact that someone would volunteer their time for a nonprofit and then use that opportunity to line their own pockets is an outrage," says Andrew Tiedemann, communications director for alumni affairs and development at Harvard. "We have never seen anything remotely like this in Harvard history."

One of Mr. Earls's most important fund-raising assignments was Robert Bass, one of the well-known Bass brothers from Texas, who had made numerous high-profile investments in the 1980s. The two men met in connection with Harvard Parents Fund activities, and Mr. Bass's daughter Chandler, who entered Harvard in 1996, became "good friends" with Mr. Earls's daughter Kate, Mr. Bass testified.

Continued in the article

Bob Jensen's threads on fraud are at 

Consumer fraud protections are discussed at 

I have mixed feelings about convicts exploiting their misdeed experiences for huge lecture and speaking fees.  They often do have valuable and inspirational speeches and recorded material, but should they be making huge fees after serving time for ripping off the public.  In fairness, some to some pro bono presentations for schools, but in most instances their fees are enormous for speeches and lectures.

"After Serving Time, Executives Now Serve Up Advice," by Christopher S. Stewart, The New York Times, June 1, 2004 --- 

Corporate executives facing trials for misdeeds at work are grappling with the possibility of a long stretch in prison. But they can take comfort in the fact that business is booming for a few executives-turned-felons who have turned their stories into topics on the lecture circuit.

From a former finance executive to a lawyer who specialized in civil litigation, some white-collar criminals are getting paid several thousand dollars to talk about their crimes to business schools, professional associations and corporations.

"It's a powerful message," said Kellie McElhany, professor of corporate management at the Haas School of Business at the University of California, Berkeley. She has had Walter Pavlo, the former senior manager of collections at MCI who spent more than a year and a half in prison after he was convicted of wire fraud and money laundering, speak at the school's Center for Responsible Business.

"You actually get to see the consequences of poor ethical decision making," Professor McElhany said.

Gary Zeune, who runs Pros & Cons, a speaker agency in Columbus, Ohio, that specializes in former white-collar criminals, says demand has increased about 30 percent in the last year, helped by the prominent trials of executives like Martha Stewart and L. Dennis Kozlowski, the former Tyco chief executive.

At the same time, a growing number of executives appear to be willing to talk about their misdeeds. Mr. Zeune gets phone calls, e-mail messages and letters almost every other week from former criminals, he said, more than double the number of requests he received two years back. Speakers at his agency are paid $1,000 to $3,000.

But the phenomenon is unlikely to last, said Toby Bishop, president and chief executive of the Association of Certified Fraud Examiners, who has used convicted executives to conduct training and to lecture.

Corporate crime is "just a hot topic now," he said. "And in two or three years, if there are no more corporate scandals, it will be replaced by something else."

But for now, white-collar criminals are in demand. Mr. Pavlo of MCI is one of Mr. Zeune's most popular speakers. Since his release in 2003, he has earned more than $30,000.

In his speeches, Mr. Pavlo talks about how he devised a complicated accounting scheme with an outside partner that yielded $6 million in stolen customer money in six months, and he describes what he was thinking at the time of the crime.

This year, he says, he could earn $150,000 to $200,000, charging as much as $5,000 for a speech.

Andrea Bonime-Blanc, senior vice president and chief ethics and compliance officer at the New York office of Bertelsmann Media Worldwide, hired Mr. Pavlo in March for a quarterly executive meeting she holds on the topic of ethics. While it was the first time she had hired a former convict, she said it went over very well.

Karen Bond, a lawyer in Ohio who served 38 months for interstate securities fraud, has talked widely in the media about Martha Stewart's conviction for lying about her sale of ImClone Systems stock. Her speaking run, however, may be short-lived. A spokesman for Ms. Bond, Somer Stephenson of Stephenson Consulting Group in Califon, N.J., said she was no longer available, citing probation issues. Ms. Bond did not return repeated phone calls for comment.

Mark Morze was convicted in the late 1980's of stock fraud, wire fraud and tax evasion while an executive at the carpet cleaning company ZZZZ Best. After emerging from prison in 1994, he hit the speaker's circuit and says he has consistently made $60,000 to $80,000 a year. Mr. Morze is a regular at the Graziadio School of Business at Pepperdine University, where his message is deterrence.

The presence of corporate felons on the talk circuit has been reported by Crain's New York Business.

Public speaking is not a real option for most white-collar criminals, Mr. Zeune said. "You have to have a compelling story and take responsibility for what you did, which is something a lot of criminals won't do."

Even for the few who find speaking jobs, success can be elusive.

David London, who served 11 months for fraud committed while he was chief executive of the former People's Bank of Unity in Pennsylvania, worked as a clerk at a local medical center and did general labor for a film studio after he was released in 1998. Today, he is a speaker with Mr. Zeune's group, but he gives only a handful of lectures a year, making pocket money. He lives in the extra room of an old friend's house and, to make ends meet, he works as a mortgage broker and officiates at college and high school sporting events.

"I can't get a decent job anymore," Mr. London, 61, said. "All my life was in banking, over 30 years. Even if I tried to get a night job at a hotel in auditing, I wouldn't be able to get it. "

Bob Jensen's threads on proposed reforms are at 

June 9, 2004 reply from Ed Scribner [escribne@NMSU.EDU


At least, as I understand it, Barry Minkow donates his speaking fees to restitution fund for the victims of ZZZZBest.


June 9, 2004 reply from Bill Dent [billdent@UTDALLAS.EDU


I am not sure "donates" is the appropriate term. According to Knapp in his book, Contemporary Auditing--Real Issues and Cases, the federal court ordered Mr. Minkow to pay the victims of the ZZZZ Best fraud $26 million.


In a case that illustrates what used to be common practice before Sarbanes-Oxley became law, Big Four accounting firm PricewaterhouseCoopers agreed to pay $50 million to settle a class action suit involving its former audit client Raytheon. 

Bob Jensen's threads on PwC scandals are at 

From the Scout Report on May 7, 2004

World Bank: Anticorruption ---

In its many different guises, corruption around the world tends to affect the poor, who are often the most reliant on the provision of public services, and are also least likely to be able to pay the extra costs associated with bribery and fraud. The World Bank has identified corruption as "the single greatest obstacle to economic and social development," and thusly has set up this anticorruption website to serve as an online resource for policy-makers, non-governmental organizations (NGOs), and other interested parties. On the site, the World Bank lays out its strategy for combating corruption, which includes increasing political accountability, strengthening civil society participation, and improving public sector management. The site also contains a number of helpful resources, such as toolkits for assessing government performance in this area, and information and reports on various regional and country-based approaches to dealing with corruption. The site is rounded out by a calendar of events and key strategy documents, such as "Reforming Public Institutions and Strengthening Governance, A World Bank Strategy."

TITLE: Loophole Limits Independence 
REPORTER: Deborah Solomon 
DATE: Apr 28, 2004 
PAGE: C1,4 
TOPICS: Financial Accounting Standards Board, International Accounting Standards Board, Corporate Governance

SUMMARY: The Solomon article, as well as the related articles, outlines the efforts to "reign-in" the abuses that have been exposed in the governance of some of the biggest corporations in the country in the past several years. The related articles by Burns, Hymowitz, Maremont and Bandler delineate what "should be." The current article depicts, in some cases, what "is."

1.) What function is served by the compensation committee of a company? Explain in terms of the competing incentives for compensating the chief executives of a firm.

2.) What is a nominating committee? Why is it important that directors be independent?

3.) It has been argued that the underlying philosophy of international accounting standards versus American accounting standards are that the international standard-setting focus is on the "end-product" while the American focus is on the "process." Critics of the American system maintain the focusing on the process provides a roadmap to those disinclined to adhere to the "intent" of the standards. Argue that this is happening in the corporate governance area. Explain in terms of the first paragraph of the Solomon article which begins with, "Dozens of companies are avoiding new rules."

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

|TITLE: Everything You Wanted to Know About Corporate Governance . . . 
REPORTER: Judith Burns 
PAGE: R5-6 
ISSUE: Oct 07, 2003 

TITLE: How to Be a Good Director 
REPORTER: Carol Hymowitz 
PAGE: R1-4 
ISSUE: Oct 27, 2002 

TITLE: Now Playing: Corporate America's Funniest Home Video 
REPORTER: Mark Maremont and James Bandler 
PAGE: A1-8 
ISSUE: Oct 29, 2003 

Bob Jensen's threads on corporate governance are at 

"Loophole Limits Independence," by Deborah Solomon, The Wall Street Journal, April 28, 2004, Page C1 ---,,SB108311078032395529,00.html 

Dozens of Firms Use Exemption
That Allows Them to Avoid
Rules Mandating Board Structure

Dozens of companies are avoiding new rules intended to make their boards more independent from management, taking advantage of a little-noticed exemption for corporations that are controlled by small groups of shareholders.

The list includes Cox Communications Inc., EchoStar Communications Corp. and Weight Watchers International Inc., which have said in Securities and Exchange Commission filings that a majority of their directors won't be independent. Primedia Inc., Cablevision Systems Corp. and others have said they won't have independent compensation committees to determine executives' pay or independent nominating committees to select director candidates.

These companies are able to escape the new rules required by the New York Stock Exchange and the Nasdaq Stock Market by designating themselves as "controlled" companies in which more than 50% of the voting power rests with an individual, a family or another group of shareholders who vote as a block or another company. This allows them to avoid requirements that were adopted by stock exchanges and regulators after the corporate meltdowns of the late 1990s.

The rules mandate a majority of directors be independent and only independent directors sit on nominating, compensation and audit committees. Independent directors are those who don't work at a company, haven't been employed there within three years and don't have close relatives who work there. All firms must have independent audit committees, even those with a controlling shareholder.

The exemptions are riling some large institutional investors and corporate-governance experts who say they are weakening safeguards established to protect investors and the broader market. They also raise troubling issues at companies where a controlling shareholder may have substantial voting interest but a small economic stake, the critics say.

Don Kirshbaum, the investment officer for policy at the Connecticut State Treasurer's office, said the state became concerned when Dillard's Inc. disclosed that it planned to avoid the rule requiring a majority of directors be independent and that an independent nominating committee select director candidates. The family that controls the Little Rock, Ark., retailer retains 99.4% of voting power through Class B shares. The company's bylaws allow the family to elect eight of its 12 directors, although the Dillard family holds less than 10% of shares outstanding. "This just seemed baffling to us," said Mr. Kirshbaum. "How can a company that is owned mostly by institutional and other investors outside the family not be allowed to elect a majority of the board?" A Dillard's representative said shareholders knew when they bought the stock that the family had the right to elect a majority of the board.

Connecticut's State Treasurer and the Council of Institutional Investors unsuccessfully lobbied the Big Board and the SEC against the exemption. But the SEC signed off on it when it approved the new corporate-governance standards last year.

Under the exemption, "controlled" companies can opt out of the rules on the makeup of boards and their compensation and nominating committees by disclosing that they are controlled companies and outlining the exemptions they plan to take. Approval from regulators or shareholders isn't required. The exemption was written into the rules at the behest of companies with controlling shareholders, according to regulatory officials. When a first draft of the listing standards didn't contain the exemption, some companies lobbied the Big Board and Nasdaq, saying it didn't make sense to require companies with a controlling shareholder to have a majority of independent directors because the large shareholder effectively controlled the board.

"The exception ... was made because the ownership structure of these companies merited different treatment," the New York Stock Exchange said. "Majority voting control generally entitles the holder to determine the makeup of the board of directors, and the exchange didn't consider it appropriate to impose a listing standard that would in effect deprive the majority holder of that right." A spokeswoman for Nasdaq said the exemption "acknowledges the unique ownership rights of a majority controlled company."

Cox Communications, which qualifies for the exemption because it is controlled by the Cox family's Cox Enterprises Inc., said it "doesn't need to have a majority of independent directors for shareholders to be protected because the controlling company's interests are aligned with the shareholders."

Securities lawyers said the exemption was designed in large part for companies controlled by publicly traded parents, such as Kraft Foods Inc., controlled by Altria Group Inc. Because Altria shares trade on the Big Board and are widely held, it must comply with the standards, giving Kraft shareholders protection at the parent company level. But many of the companies that have opted out aren't controlled by a publicly traded parent.

Primedia, a New York publisher, disclosed in an SEC filing earlier this month that it wouldn't have a majority of independent directors or an independent compensation committee and that board nominations would be made by all directors instead of an independent committee. More than 50% of Primedia's voting power is held by investment partnerships controlled by Kohlberg Kravis Roberts & Co.

Continued in the article

Bob Jensen's threads on corporate governance are at 

In essence, the U.S. tax code gives [U.S. multinationals] more in tax breaks for foreign operations than it collects in revenues.
John D. McKinnon (See below)

From The Wall Street Journal Accounting Educators' Review on May 7, 2004

TITLE: U.S. Overseas Tax is Blasted
REPORTER: John D. McKinnon
DATE: May 05, 2004
PAGE: A4 LINK:,,SB108370777246501914,00.html 
TOPICS: Tax Laws, Taxation

SUMMARY: A study undertaken by Congress's Joint Committee on Taxation concludes that the U.S. government, if it were to switch to a territorial approach to taxation, would collect "$60 billion more over 10 years than the current system would raise." "In essence, the U.S. tax code gives [U.S. multinationals] more in tax breaks for foreign operations than it collects in revenues..."

1.) What is the overall objective of current U.S. tax law with respect to multinational corporations? What is the objective of tax breaks and deductions allowed against income earned by multinationals in other countries?

2.) How is it possible that the current status of U.S. tax law results in a system which costs the U.S. government more than it collects in tax revenues from this system? How would a "territorial approach" to taxation differ from this current system?

3.) Tax law is designed not only to raise revenues for the government but also to encourage behavior beneficial to society and the economy. How do some argue that current tax law influences corporate decisions in locating operations and resultant job growth prospects?

4.) Others argue that changes to current tax law would do more harm than good in influencing job growth in the U.S. economy. What are the factors that argue against changing the current tax law in this area? Specifically comment on how these factors influence U.S. job growth prospects.

5.) A spokesman for Eli Lilly, the pharmaceutical company, says his employer considers a variety of factors in deciding where to locate operations. Suppose that you are a top manager considering opening a new operation to serve a foreign market that covers several countries. List all factors that you expect to consider in your decision making process.

6.) What "added bonus for companies' reported profits" comes with income earned in low-tax countries which management commits to reinvest in those countries? Through what mechanism does this decision influence reported profits? That is, specifically describe what income statement accounts are influenced by this decision and why the accounting reflects this influence.

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

TITLE: Review & Outlook: Export Tax Follies
ISSUE: May 05, 2004

Bob Jensen's threads on the sham called the U.S. Corporate Tax code are at 

The company's auditor, Ernst & Young, paid $335 million to settle.

"Before Enron, There Was Cendant," by Gretchen Morgenson, The New York Times, May 9, 2004 --- 

The fraud that time forgot is finally going to trial.

Tomorrow in Federal District Court in Hartford, opening arguments are scheduled to begin in the case against Walter A. Forbes, former chairman of the Cendant Corporation, and E. Kirk Shelton, former vice chairman. The government has accused the two men of orchestrating a titanic accounting and securities fraud that misled investors over a decade beginning in the late 1980's. The trial will open more than six years after the problems at Cendant came to light.

Cendant was formed in late 1997 when CUC International, a seller of shopping-club memberships that was run by Mr. Forbes, merged with HFS Inc., a hotel, car-rental and real estate company overseen by Henry R. Silverman.

Three months after the merger, Cendant disclosed evidence of accounting irregularities; the stock lost almost half its value in one day. Later, Cendant told investors that operating profits for the three years beginning in 1995 would be reduced by $640 million.

Mr. Forbes and Mr. Shelton have been accused of securities fraud, conspiracy and lying to the Securities and Exchange Commission. The charges of fraud and making false statements to regulators each carry a maximum penalty of 10 years in prison and a $1 million fine. Mr. Forbes is also accused of insider trading, relating to an $11 million stock sale he made about a month before the accounting irregularities were disclosed.

Both men have pleaded not guilty. Mr. Forbes's lawyer did not return a phone call requesting an interview. Mr. Shelton's lawyer said: "He is innocent and expects to be vindicated."

Thanks to the creative corporate minds at Enron, WorldCom, Tyco and Adelphia, investors are up to their necks in revelations of accounting shenanigans. But the scandal at Cendant still ranks as one of the world's costliest corporate calamities.

The day after the company disclosed evidence of accounting irregularities, holders of Cendant stock and convertible bonds lost more than $14 billion. And in 2000, Cendant, now based in New York, paid $2.85 billion to settle a securities suit filed by investors who had bought its stock. The company's auditor, Ernst & Young, paid $335 million to settle.

And the scandal is still costing Cendant. Under the company's bylaws, Mr. Forbes is entitled to reimbursement for his legal fees, which are running $1 million a month, according to court documents. The company can sue to recover the fees if Mr. Forbes is convicted.

Cendant has also sued Mr. Forbes to recover $35 million in cash and $12.5 million worth of stock options he received after he resigned from the company in July 1998.

Prosecutors have built their case against Mr. Forbes and Mr. Shelton with help from three former CUC financial executives who have pleaded guilty to fraud. The case has taken six years to reach the courtroom, in part because lawyers for Mr. Forbes and Mr. Shelton persuaded a judge to move the trial from New Jersey, where Cendant had been based, to Hartford, closer to Mr. Forbes's home in New Canaan, Conn., and Mr. Shelton's home in Darien, Conn.

Continued in article

Bob Jensen's threads on Ernst & Young scandals are at 


Federal investigators have launched a criminal investigation into Ernst & Young's tax shelter practices, despite the $15 million settlement the firm reached on the matter last year with the IRS. 

Related News: 

Bob Jensen's threads on Ernst & Young scandals are at 

"Ernst & Young Faces Informal SEC Inquiry Of Consultant's Pay," by Joann S. Lublin and Johathan Weil, The Wall Street Journal, June 8, 2004, Page C1 ---,,SB108664493445730875,00.html?mod=home_whats_news_us 

Ernst & Young LLP hoped the $377,500 it paid a marketing consultant would deliver results. It did -- only not the sort it wanted.

The Securities and Exchange Commission has begun an informal inquiry into whether the money paid to the consultant impaired the accounting firm's independence as an outside auditor at three companies: executive-search firm Korn/Ferry International, big-box retailer Best Buy Co. and TeleTech Holdings Inc., which runs telephone call centers. The "leadership development" consultant, Mark C. Thompson, was sitting on the boards of the three companies while working for Ernst & Young.

News of the SEC's inquiry comes less than two months after the commission barred Ernst from accepting new audit clients for six months because of auditor-independence violations at former audit client PeopleSoft Inc. The SEC criticized Ernst in that case for not having sufficient internal procedures to guard against such violations.

Unlike the PeopleSoft case, which involved nearly $500 million of revenue that Ernst received from the software maker, the latest inquiry focuses on much-smaller payments made by Ernst itself. Those payments were made from December 2002 through April 2004, ending at about the time of the suspension handed down by an SEC administrative-law judge in the PeopleSoft matter.

Whether the payments by Ernst constituted an auditor-independence violation will hinge on whether the agency determines that the firm made them as a consumer in the ordinary course of business, which is the only exception to the SEC's general rule that auditors not enter into business relationships with audit clients.

Continued in article

Bob Jensen's threads on Ernst & Young scandals are at 

The SEC is considering legal action against PepsiCo's beverage and snack units for allegedly helping Kmart Holding Corp. inflate its revenue in 2001.

"SEC Advises Pepsi 2 Units May Face Civil Legal Action, by Chad Terhune, The Wall Street Journal, May 3, 2004 ---,,SB108334777644098776,00.html?mod=home_whats_news_us 

PepsiCo Inc. said the Securities and Exchange Commission is considering legal action against its beverage and snack units for allegedly helping Kmart Holding Corp. inflate its revenue in 2001.

PepsiCo said Friday that it received so-called Wells notices in connection with actions taken by a "nonexecutive" employee at its Pepsi-Cola unit and another such employee at its Frito-Lay unit. A Wells notice is how the SEC discloses that it is considering whether to file a civil lawsuit against a company.

The SEC notices allege that a Pepsi-Cola employee signed documents involving $3 million in payments to Kmart, allowing the retailer to improperly record the timing of the revenue. The SEC further alleges that a Frito-Lay employee signed similar documents involving $2.8 million in payments to Kmart, according to PepsiCo.

PepsiCo, based in Purchase, N.Y., said it is cooperating fully with the investigation and submitting reasons why it doesn't believe an action should be brought.

Kmart, of Troy, Mich., said that it previously terminated all employees it determined were responsible for the improper recording of vendor allowances. It also said its financial statements for fiscal 2001 and prior years were restated to correct these improperly recorded transactions.

The U.S. Attorney's office in Detroit and the SEC continue to investigate Kmart's business practices; the company has said it is cooperating fully with investigators.

A spokesman for the SEC declined to comment.

PepsiCo's Frito-Lay unit received a similar Wells notice from the SEC last fall concerning $400,000 in payments to grocery distributor Fleming Cos. Mark Dollins, a spokesman for PepsiCo, said the SEC still is reviewing the Fleming issue and "we expect a resolution on that in the near future."

Continued in the article

Bob Jensen's threads on revenue accounting are at 

Who is most likely to commit a fraud within a corporation?

I found this KPMG study outcome most interesting.

The fact that most of fraudsters are males from the "Finance Department" (which probably includes accounting) does not surprise me.  What surprised me at first was their seniority and age, but then perhaps the internal controls are weaker at the higher levels of management.  

What may be a surprise to you is the fact that many persons who knew enough to blow the whistle did not blow the whistle.  This didn't surprise me, however, since whistle blowing has few rewards relative the trouble it can get you into.  Since Sarbanes-Oxley, however, there will be greater opportunities for anonymous whistle blowing.  However, Sarbanes-Oxley is not likely to change the corporate culture overnight (if ever?) as long as whistle blowing is not rewarded --- 

"Long-Serving, Male Execs Most Likely to Commit Company Fraud," AccountingWEB, April 27, 2004 --- 

A study conducted by by KPMG has revealed some interesting information about the typical perpetrator of a fraud, why they steal and who they target. Seventy-two percent of cases involve men only. Over half of company fraud involves two to five people. Forty percent of fraud involves employees from the finance department.

The analysis examines 100 of the fraud cases that KPMG has been called in to investigate over the past two years, from which a profile of a fraudster has been created. Alex Plavsic, national head of fraud investigations at KPMG, said: “One of the alarming findings from the study was the seniority of the perpetrators - we found that directors or senior managers committed almost two thirds of the 100 cases surveyed." “Fraud can have a devastating effect on a business, both from a financial and reputational perspective, which is why most companies try to keep the discovery of fraudulent activity as quiet as possible.”

Who? The analysis found that many of the perpetrators were long serving employees - 32 percent of them had been working for their companies for between 10 and 25 years. And they were not operating alone - in more than half of all the cases (51 percent) two to five parties were involved in the fraud, compared with only one in three cases carried out solely by the perpetrator. The number of people involved in some of the cases (more than five people in ten percent of them) is indicative that fraud can be endemic within some departments and consequently more difficult for outsiders to detect. In one case analysed, 207 individuals were involved in a single fraud.

In 72 percent of cases, the fraudsters were found to be male-only. Female-only fraudsters were identified in seven percent of cases and both male and females were involved together in some 13 percent of cases. In the remainder of cases, no perpetrator was identified. The age of the principal fraudster was typically between 36 and 45 (41 percent of cases). 29 percent of cases involved those aged between 46 and 55. Those aged between 18 to 25 made up only one percent of perpetrators.

The finance department is the most likely business area that the fraudster targeted or was responsible for (40 percent of cases). Procurement was the next most likely area (12.5 percent), while one in ten frauds occurred in the sales area.

How? A weak control environment was the primary reason. In half of the cases surveyed, this was the weakness exploited by the fraudster. In nearly one in three incidents it was the perpetrator abusing their key authorities. Just over one in ten frauds were achieved by the fraudster operating in alliance with others to circumvent controls. While the finance department is often perceived as guardian of control, it remains the top opportunity and target for fraudsters.

And if company directors are hoping that their internal controls are robust enough to pick up fraud they are likely to be disappointed - only one in four were detected by a management review. 31 percent of frauds were discovered following an employee blowing the whistle, an anonymous tip-off or a report by an external third party. Whistle-blowing is an important weapon in the fight against fraud, despite this, the survey found that while four in ten employees were aware of or suspected that a fraud was occurring, they took no action.

Why? Personal gain was the most likely reason (41 percent) for committing fraud. External pressures were also a trigger for fraudulent activity with one in eight cases caused by the perpetrator getting into financial difficulties. In nearly 33 percent of the cases the amount stolen was more than £1 million while in 26 percent of the cases, it was more than £100,000.

How do companies respond? Dismissal of the perpetrator was the most common response with 55 percent of the fraudsters being fired. However, in just under one in five cases no sanction was taken and this may be because of concerns about the reputational impact of fraud becoming known.

This is borne out by the fact that in 69 percent of cases there was no publicity surrounding the investigation or subsequent sanction, while only six percent of companies chose to publicise the fraud.

On a positive note, in a third of cases, businesses had recovered or were taking action to recover cash or assets following a fraud. Alex Plavsic adds: “This study has highlighted some worrying findings, and particularly demonstrates the need for companies to continually review their internal controls. Regular testing of key controls against the risk of fraud will identify any weaknesses in the system, which could easily be exploited by potential fraudsters."

“Internal controls can only be effective if companies have the right culture in place. A breakdown in the control framework and the integrity of individuals, is when fraud is most likely to be perpetrated.”

Bob Jensen's threads on corporate fraud are at 


THE KPMG TAX SHELTER that the IRS last year declared abusive was used by 29 companies to generate at least $1.7 billion in tax savings, according to the companies and internal KPMG documents.

"KPMG Shelter Shaved $1.7 Billion Off Taxes of 29 Large Companies," The Wall Street Journal, June 16, 2004, Page A1 ---,,SB108734112350838166,00.html?mod=home_whats_news_us

The IRS has said the shelter generated at least $1.7 billion in tax savings for more than two dozen companies. Previously undisclosed internal documents from KPMG, which marketed the shelter, list a host of brand-name companies that agreed to buy it.

Delta Air Lines, Whirlpool Corp., Clear Channel Communications Inc., WorldCom Inc., Tenet Healthcare Corp. and the U.S. units of AstraZeneca PLC and Fresenius Medical Care AG all used the shelter, according to the companies and the KPMG records, which were reviewed by The Wall Street Journal.

The KPMG documents show that Qwest Communications International Inc., Washington Mutual Inc., Global Crossing Ltd., Lennar Corp. and the U.S. units of Cemex SA and Siemens AG signed agreements to buy the shelter, but those companies wouldn't say whether they implemented it.

The internal KPMG records, covering the years 1999 through 2001, offer a rare look at the inner workings of a highly aggressive shelter that KPMG sold under the name "contested liability acceleration strategy," or CLAS. The records also provide a look at what nearly all the past year's government investigations into KPMG and other tax-shelter promoters have kept a well-guarded secret: the identities of companies that bought so-called abusive tax shelters.

According to a July 2002 sworn statement filed by an IRS agent with a federal district court in Washington, 29 corporations bought CLAS from KPMG, realizing at least $1.7 billion in tax savings. The statement, based on information KPMG provided in response to an IRS summons, didn't name the companies.

By that measure, CLAS was more costly to the federal Treasury than any of the four KPMG tax shelters that were the subject of hearings held last November by the Senate's Permanent Subcommittee on Investigations, which focused mainly on shelters sold to wealthy individuals. As previously reported, a federal grand jury in Manhattan is investigating KPMG's past tax-shelter activities. It's not clear what penalties, if any, the IRS may seek from KPMG in connection with CLAS or other past shelter sales.

The IRS declared the tax shelter to be abusive in November 2003, after the 29 companies had bought it from KPMG. Still, "no one purchases a shelter like this without knowing they're taking significant risks," said Joseph Bankman, a tax-law professor at Stanford University. "It's a classic case of getting something for nothing."

By declaring the shelter abusive, the IRS served notice that companies using CLAS face heightened disclosure requirements and potential penalties. In some instances, companies that used the shelter already have resolved IRS tax inquiries by abandoning the strategy. Others say their discussions with the IRS are continuing. There is no indication of any criminal investigation into the corporate users of CLAS.

Some former KPMG tax partners familiar with CLAS estimate that it generated $20 million in fees for the firm. Officials at KPMG, the smallest of the Big Four accounting firms, declined to discuss CLAS for this article.

KPMG created CLAS to help companies accelerate the timing of tax deductions for settlements of lawsuits or other claims. Deductions usually aren't allowed until claimants are paid. One exception under the federal tax code involves transferring money or other property, under certain limited conditions, to a "contested liability trust" before the claims are resolved.

Under the CLAS strategy, a KPMG client would establish a trust with itself as the beneficiary. It then transferred noncash assets -- sometimes company stock but usually a kind of IOU called an intercompany note -- to the trust. The items represented amounts the client supposedly expected to pay to resolve claims it was still contesting. The client took corresponding deductions, reducing taxable income.

In a March 2004 e-mail, a KPMG attorney told partners and managers that CLAS had been added to the IRS's list of abusive transactions.Under the IRS's November 2003 notice, the KPMG shelter had several flaws. For instance, the client continued to control the trust's assets. To qualify for a deduction, a taxpayer must relinquish control over the trust's property, the IRS said.

A 1999 internal KPMG synopsis said the firm charged a fixed fee that approximated 0.4% of the accelerated deduction, with a minimum fee of $500,000. It said the optimal CLAS client had at least $150 million of pending claims for things like shareholder lawsuits, personal-injury claims or environmental actions. KPMG later relaxed those minimum requirements.

Typically, KPMG salespeople pitched the shelter to a company's chief financial officer or vice president for tax. A January 2000 KPMG slide presentation called CLAS "an aggressive strategy" and told tax partners and managers to target companies that had "implemented risky strategies in the past."

The firm's marketing materials included talking points for salespeople. One slide in the 2000 presentation said: "The true beauty is what is not required -- cash!" The talking points also suggested responses to typical objections from target companies.

If a prospective client objected on the grounds that "it's too good to be true," salespeople were advised to respond: "Three elements are involved in any tax strategy: Legislation, regulation and court interpretation. Looking at the legislation alone it is to [sic] good to be true. However, legislation, regulation and court interpretation combined allow the strategy to work. KPMG's advantage: We were involved in drafting the regulations and are acutely aware of the opportunity."

The KPMG partner in charge of developing and marketing CLAS was Carol Conjura, a former IRS official based in Washington, according to people who worked with her. Through a KPMG spokesman, Ms. Conjura declined to comment.

Critics for years have complained that accounting firms compromise their objectivity when they sell aggressive tax strategies to audit clients, because they may end up auditing their own work. KPMG spokesman Thomas Fitzgerald said the firm "provides tax services to audit clients as permitted by the SEC's auditor-independence rules and consistent with all applicable professional and regulatory rules as well as the client's own policies." He declined to comment further.

Tenet, the nation's second-largest hospital operator, used the CLAS strategy to accelerate its deductions for medical-malpractice claims. A Tenet spokesman said the company, which is also an audit client of KPMG, has "complied with all the related disclosure obligations required by the IRS" and has "discontinued utilizing this strategy on a prospective basis." He said, "It is premature and speculative to determine if the IRS will deny the tax deductions claimed by Tenet." He declined to discuss the shelter's effect on KPMG's independence.

At Clear Channel, the nation's largest radio-station operator, a spokeswoman said, "Had we known it was going to be classified as a shelter, we wouldn't have bought it." A Whirlpool spokesman said the appliance maker contacted the IRS after its November notice and reached a resolution a couple of months ago; he declined to discuss specifics.

MCI Inc., the telecommunications concern formerly known as WorldCom, confirmed buying the shelter. A person familiar with the transaction said WorldCom bought it in 1999 and used it to accelerate several hundred million dollars in deductions over a three-year period. This person said the company unwound the shelter and reversed the deductions in 2002, a year when its losses related to accounting fraud were so huge that they wiped out the deduction reversals. The company replaced Arthur Andersen LLP as its outsider auditor with KPMG in 2002. MCI and KPMG have come under criticism this year over revelations about an aggressive state-tax shelter that KPMG sold the company during the late 1990s.

The internal KPMG records reviewed by the Journal show that Wells Fargo & Co., a financial-services company audited by KPMG, signed an agreement to buy CLAS and completed the engagement in 2000. A Wells Fargo spokeswoman confirmed that "KPMG provided contested liability-tax services to Wells Fargo in 2000." However, she said, "Wells Fargo did not implement any strategy that was disallowed" by the IRS's November notice, adding that "Wells Fargo was not affected by this notice." She declined to explain further.

An AstraZeneca spokeswoman said the drug maker "made the appropriate disclosures in accordance with the IRS guidance" and resolved the matter with the IRS without penalty. A Fresenius executive said the health-care company "is in active discussions with the IRS." AstraZeneca and Fresenius, which are both KPMG audit clients, said their audit committees had reviewed the matter.

A Delta spokeswoman said the company "can't comment on tax periods still under audit." A person familiar with Delta's transaction said the airline unwound CLAS shortly after implementing it in 2000. Siemens, Cemex and Qwest, also KPMG audit clients, declined to comment, as did Washington Mutual, Lennar and Global Crossing.


How did a "Short Option Strategy" help to land KPMG in court?


"KPMG Is Ordered To Release Data Under IRS Probe," by Jonathan Weil, The Wall Street Journal, May 5, 2004 ---,,SB108370830560201939,00.html?mod=home_whats_news_us 

A federal judge ordered KPMG LLP to turn over documents related to its sales of several tax shelters now under investigation by the Internal Revenue Service, rejecting the accounting firm's arguments that producing the records would violate client-confidentiality obligations.

A KPMG spokesman said the firm was reviewing the judge's opinion and order and had no comment. The IRS released a one-sentence statement from Commissioner Mark V. Everson, who said, "Slowly but surely, we are unmasking the false claim of privilege made by those who are merely promoting generic abusive tax products."

The ruling by U.S. District Judge Thomas F. Hogan of Washington marks the latest twist in the IRS's two-year civil investigation into KPMG's promotions of various tax shelters in recent years, some of which the IRS has designated as abusive transactions. In a December court filing on behalf of the IRS, the Justice Department accused KPMG of improperly withholding shelter-related documents from the agency and engaging in improper delaying tactics. Separately, a federal grand jury is conducting a criminal investigation into KPMG's former tax-shelter activities.

In a sometimes harshly worded 24-page opinion, Judge Hogan wrote that KPMG had undercut its client-confidentiality claims by making misleading statements about the content of many of the documents at issue, citing a report by a court-appointed magistrate who reviewed the documents. "After carefully reviewing the entire record of this case, the court comes to the inescapable conclusion that KPMG has taken steps since the IRS investigation began that have been designed to hide its tax shelter activities," Judge Hogan wrote.

Among other findings, the judge wrote that KPMG had told an IRS investigator that its involvement in one shelter, called Short Option Strategy, was limited to preparing and giving advice about tax returns, when in fact KPMG was involved in developing and marketing the shelter. Other times, the judge wrote, "KPMG appears to have withheld documents summoned by the IRS by incorrectly describing the documents to support dubious claims of privilege."

The documents sought by the IRS include e-mails from KPMG officials concerning the accounting firm's dealings with the law firm Brown & Wood, which issued opinion letters to many KPMG tax-shelter clients; Brown & Wood, of New York, in 2001 merged with the Chicago law firm Sidley & Austin. Rather than dealing with privileged client matters, the judge wrote, the documents instead represented "further evidence suggesting that Brown & Wood was not engaged in rendering true legal advice, but was rather a partner with KPMG in its tax shelter marketing strategy."

As part of his ruling, Judge Hogan postponed deciding whether KPMG must produce copies of the opinion letters issued by Brown & Wood and its successor firm, Sidley Austin Brown & Wood LLP. He ordered KPMG to either produce the opinion letters voluntarily or submit a more detailed log of the documents that states why each opinion letter shouldn't be produced to the IRS. Sidley Austin officials couldn't be reached for comment.

The judge also gave KPMG 10 days to produce the other documents at issue and to identify to the IRS any participants in tax shelters that it previously had withheld.

Bob Jensen's threads on KPMG's legal troubles are at 

It Just Gets Deeper and Deeper for KPMG

"KPMG, BearingPoint Agree To Pay $34 Million Settlement," by Honathan Weil, The Wall Street Journal, April 2, 2004 ---,,SB108094506815173092,00.html?mod=home_whats_news_us 

KPMG LLP, the fourth-largest U.S. accounting firm, and its former consulting unit, BearingPoint Inc., agreed to a pair of settlements with a total value of $34 million to resolve their portions of a class-action lawsuit that accused them of fraudulently overbilling clients for travel-related expenses.

The preliminary agreements, under which KPMG and BearingPoint each agreed to settlements valued at $17 million, mark the latest development in the travel-billings litigation ongoing in a Texarkana, Ark., state court. Under the terms of Friday's agreements, BearingPoint and KPMG denied wrongdoing.

In December, PricewaterhouseCoopers LLP agreed to a $54.5 million settlement in the case, though it denied wrongdoing. The lawsuit is continuing against the remaining two defendants, Ernst & Young LLP and the U.S. arm of Cap Gemini Ernst & Young, a French consulting concern that bought Ernst & Young's consulting business in 2000. A separate civil investigation by the Justice Department into the accounting and consulting firms' billing practices as government contractors is continuing.

A third of the combined $34 million settlement, which was approved Friday by Miller County Circuit Judge Kirk Johnson, will go to the plaintiffs' attorneys. Class members would have the option of accepting certificates entitling them to credits toward for future services. Or they could opt to receive 60% of the certificates' face value in cash. The certificates' size would vary from client to client.

Revelations from the Texarkana lawsuit have shined a light on how some professional-services firms in recent years have turned reimbursable out-of-pocket expenses, such as bills for airline tickets and hotel rooms, into profit centers by using their size during negotiations with travel companies to secure significant rebates of upfront costs. Unlike discounts that reduce the published fare on, say, a plane ticket, rebates are paid after travel is completed, usually in lump-sum checks. When firms retain rebates on client-travel without disclosing the practice to clients, they run the risk of exposing themselves to significant legal liability, as Friday's settlements show.

KPMG and the other defendants have acknowledged retaining undisclosed rebates and commissions from travel companies on client-related travel. But they deny acting fraudulently, saying they used the proceeds to offset costs they otherwise would have billed to clients.

KPMG had continued to administer BearingPoint's program for client-related travel following BearingPoint's separation from KPMG in 2000. KPMG said it stopped accepting so-called "back-end" rebates from travel companies in 2002, shortly after the Texarkana lawsuit was filed in October 2001.

A BearingPoint spokesman said the company was "pleased that an agreement has been reached that is beneficial to all involved, recognizing that it's a liability we inherited for a program we didn't create." He said the company previously had established reserves on its balance sheet in anticipation of a settlement and anticipates "no impact on current or future earnings."

A KPMG spokesman said: "KPMG considers this settlement a fair and reasonable solution to the litigation. While we firmly believe that the KPMG travel program operated to our clients' substantial benefit and that we would prevail at trial, this settlement will end what promised to be a long and costly litigation."

Whether clients benefited or not, internal KPMG records on file at the Texarkana courthouse suggest that KPMG operated its travel division as a profit center and regarded its proceeds from travel rebates as earnings for the firm.

One of those documents was a 1999 memo by the firm's travel unit that said the travel unit "will return $17 million to the firm. As large a profit as any of the firm's most important clients." Another KPMG document contained a spreadsheet called "earnings from travel" that showed $19.1 million in such earnings for fiscal 2001 and $17.4 million in such earnings for fiscal 2000.

The plaintiffs leading the Texarkana lawsuit are Warmack-Muskogee LP, a former PricewaterhouseCoopers client that operates an Oklahoma shopping mall, and Airis Newark LLC, a former KPMG client based in Atlanta that builds airport facilities.

"We are extremely pleased with the results that we were able to obtain for these clients," said Rick Adams, an attorney for the plaintiffs at the Texarkana, Texas, law firm Patton, Haltom, Roberts, McWilliams & Greer LLP. "We intend to continue the lawsuit against Ernst & Young and Cap Gemini."

Continued in article

Bob Jensen's threads on the woes of KPMG are at 

Most Companies Get an "F" in Fraud Prevention 

Enron had a code of conduct. Enron had a hotline. And in the end, Enron had fraud. Today, companies operate with a false sense of security because they either don't have a fraud prevention program or the program they have is a legal, yet ineffective "fig leaf." "One key to fraud prevention is to create an atmosphere where employees feel confident in reporting wrongdoing without being victimized, even if executives appear to be involved," explains Toby Bishop, president & CEO of the Association of Certified Fraud Examiners (ACFE), the largest anti-fraud association in the world. "If companies don't have effective fraud prevention programs, they are at risk of failure," says Bishop.

Years ago, working as a consultant, Bishop tested the effectiveness of an existing fraud prevention program for a major utility company. Management thought their program was working and wanted confirmation. Bishop's firm surveyed a statistical sample of employees to assess their feelings about management's commitment only to discover that employees in one division did not believe management wanted to "do the right thing," says Bishop.

"If employees perceive their company's fraud controls to be weak or if they think management is only giving lip service to ethical behavior, fraud is inevitable," Bishop warns.

In 2002 fraud prevention was one of the goals addressed in the Sarbanes-Oxley Act (SOX), legislation that affects how public organizations and accounting firms deal with corporate governance, financial reporting and public accounting. The effect of SOX has been far reaching, leading to voluntary changes in private companies and mandatory changes in public companies. But is it preventing fraud? "It may not be as effective as people expected," Bishop answers.

Over the past 18 months Bishop has taught several thousand participants how to use the ACFE's Fraud Prevention Check-Up, a tool that identifies major gaps in organizations' fraud prevention processes. None of the participants thought their organization would pass the test, which means they are at significant risk of fraud.

Bishop says while Sarbanes-Oxley invokes a basic framework for internal controls, including anti-fraud controls, additional specifics are needed to address controls to prevent fraud. "There is a definite gap in the standards used to establish fraud prevention controls, if companies use them at all."

Bob Jensen's threads on corporate fraud are at 

"Insurance Investigations Under Way Over Fees," by Josephe B. Treaster, The New York Times, April 24, 2004 --- 

Two new investigations have been opened into the insurance industry, industry executives and officials said yesterday. Both focus on incentives and other fees paid by insurance companies to commercial insurance brokers.

In New York, the office of Eliot Spitzer, the state attorney general, has issued subpoenas to the country's three biggest insurance brokers: Marsh Inc., the world's largest broker and a unit of the Marsh & McLennan Companies, which is based in New York; Willis Group Holdings, also in New York; and Aon, a Chicago company that ranks immediately behind Marsh in size. The three companies, which account for most of the commercial insurance brokerage business, all confirmed receiving the subpoenas.

In California, John Garamendi, the insurance commissioner, said last night that he was looking into potential conflicts of interest in several insurance brokerage companies across the country but declined to identify the targets.

At issue in the investigations are payments made by insurance companies to brokers for exceeding targets on the sale of policies and for providing consulting services. Although the payments have been a routine practice for many years in the industry, it is not clear whether the payments are in fact legal. Regulators and industry analysts say the costs of the bonuses are passed on to customers; there is concern, too, that customers may be getting inappropriate insurance.

Some experts say the payments are only illegal when they are not disclosed to customers, but the Washington Legal Foundation, a nonprofit research organization that brought the situation to the attention of investigators, says that, in any case, they raise questions about whether a broker's recommendations are honest and unbiased.

In a letter, the foundation noted a statement by the New York State Department of Insurance to brokers and insurance companies in 1998 saying that a failure of a broker to disclose the payments from insurance companies may be a violation of New York state insurance law "as a dishonest or untrustworthy practice.'' Through a spokesman, Gregory V. Serio, the superintendent of insurance in New York, declined to comment on the investigations.

Over the years, the risk managers who buy insurance for major corporations have expressed concerns about the insurance company payments. But neither regulators nor investigators have taken action until now.

In raising questions about the practice, Mr. Garamendi said that "the broker is presumed to work on behalf of the customer and the bonuses or commissions for volume sales, especially, can be a conflict in that they may cause the broker to divert business to an insurance company that may not provide the best deal for the insurance customer.''

Marsh, Aon and Willis Group Holding said the subpoenas demanded information on "compensation agreements" between them and the insurance companies that sell policies to American corporations.

In its statement, Aon, noted that the payments that Mr. Spitzer was investigating were "a long-standing practice within the insurance industry," adding that "many major carriers have these agreements with brokers."

Vinay Saqi, an analyst at Morgan Stanley, said in a note to investors earlier this year that the payments from insurance companies accounted for 2 to 6 percent of brokers' revenue. Most of the rest of the brokers' money comes from fees paid by corporate customers.

Continued in article

Bob Jensen's "Rotten to the Core" threads are at 

From The Wall Street Journal Accounting Educators' Review on May 27, 2004

TITLE: J.C. Penney Profit Hurt by Eckerd 
REPORTER: Kortney Stringer 
DATE: May 19, 2004 
TOPICS: Accounting, Earnings Quality, Financial Accounting, Financial Analysis, Financial Statement Analysis, Income from Continuing Operations, Net Income, Operating Income

SUMMARY: Despite an earnings increase, J.C. Penney reported a 33% decline in net income. Questions focus on the components and usefulness of the income statement.

1.) Describe the primary purpose(s) of the income statement. Distinguish between the single-step and multi-step format for the income statement. Which type of statement is more common? Support your answer.

2.) Explain the components of gross margin, operating income, income from continuing operations, net income, and comprehensive income. What is persistence? Which income statement total is likely to have the greatest persistence? Which income statement total is likely to have the least persistence?

3.) Where are results from discontinued operations reported on the income statement? Why are results from discontinued operations separated from income from continuing operations?

4.) What impact does the loss from the sale of Eckerd have on J.C. Penney's expected future net income? What impact does results from continuing operations have on expected future net income?

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

From The Wall Street Journal Accounting Educators' Review on May 23, 2002

TITLE: SEC Broadens Investigation Into Revenue-Boosting Tricks; Fearing Bogus Numbers Are Widespread, Agency Probes Lucent and Others 
REPORTER: Susan Pulliam and Rebecca Blumenstein 
DATE: May 16, 2002 
TOPICS: Financial Accounting, Financial Statement Analysis

SUMMARY: "Securities and Exchange Commission officials, concerned about an explosion of transactions that falsely created the impression of booming business across many industries, are conducting a sweeping investigation into a host of practices that pump up revenue."

1.) "Probing revenue promises to be a much broader inquiry than the earlier investigations of Enron and other companies accused of using accounting tricks to boost their profits." What is the difference between inflating profits vs. revenues?

2.) What are the ways in which accounting information is used (both in general and in ways specifically cited in this article)? What are the concerns about using accounting information that has been manipulated to increase revenues? To increase profits?

3.) Describe the specific techniques that may be used to inflate revenues that are enumerated in this article and the related one. Why would a practice of inflating revenues be of particular concern during the ".com boom"?

4.) "[L90 Inc.] L90 lopped $8.3 million, or just over 10%, off revenue previously reported for 2000 and 2001, while booking the $250,000 [net difference in the amount of wire transfers that had been used in one of these transactions] as 'other income' rather than revenue." What is the difference between revenues and other income? Where might these items be found in a multi-step income statement? In a single-step income statement?

5.) What are "vendor allowances"? How might these allowances be used to inflate revenues? Consider the case of Lucent Technologies described in the article. Might their techniques also have been used to boost profits?

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

TITLE: CMS Energy Admits Questionable Trades Inflated Its Volume 
REPORTER: Chip Cummins and Jonathan Friedland 
ISSUE: May 16, 2002 

From The Wall Street Journal Accounting Educators' Review on May 27, 2004

TITLE: SEC Gets Tough With Settlement in Lucent Case 
REPORTER: Deborah Solomon and Dennis K. Berman 
DATE: May 17, 2004 
TOPICS: Criminal Procedure, Financial Accounting, Legal Liability, Revenue Recognition, Securities and Exchange Commission, Accounting

SUMMARY: After a lengthy investigation into the accounting practices of Lucent Technologies Inc., the Securities and Exchange Commission is expected to file civil charges and impose a $25 million fine against the company. Questions focus on the role of the SEC in financial reporting.

1.) What is the Securities and Exchange Commission (SEC)? When was the SEC established? Why was the SEC established? Does the SEC have the responsibility of establishing financial reporting guidelines?

2.) What role does the SEC currently play in the financial reporting process? What power does the SEC have to sanction companies that violate financial reporting guidelines?

3.) What is the difference between a civil and a criminal charge? What is the difference between a class-action suit by investors and a civil charge by the SEC?

4.) What personal liability do individuals have for improper accounting? Why does the SEC object to companies indemnifying individuals for consequences associated with improper accounting?

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

Bob Jensen's threads on revenue accounting are at 

Bob Jensen's threads on accounting theory are at


Hi Marc,

  To his credit, Dean Powers does not appear on the list of Enron’s board members and employees who made millions in Enron stock trading ---

  The investigative report called the Powers Report commissioned belatedly by Enron’s Board is one of the most important documents available.

·         The 208 Page February 2, 2002 Special Investigative Committee of the Board of Directors (Powers) Report--- 
Alternative 2: 
Alternative 3: 
Alternative 4:  Part One | Part Two | Part Three | Part Four

"Web of Details Did Enron In as Warnings Went Unheeded," by Kurt Eichenwald and Diana Henriques," The New York Times, February 10, 2002
The article by Eichenwald and Henriques is the best summary of the 200+ page Powers report that I have seen to date

Andersen's negative response to the above report  --- 
Statement of C. E. Andrews, Global Managing Partner, in response to Enron special committee report February 2, 2002 — The report issued today by Enron’s special committee is troubling on many levels. Nothing more than a self-review, it does not reflect an independently credible assessment of the situation, but instead represents an attempt to insulate the company’s leadership and the Board of Directors from criticism by shifting blame to others.!OpenDocument   

I tend to agree with Andersen on this point.

·         "THE NUMBERS CRUNCH After Enron, New Doubts About Auditors," by David S. Hilzenrath, The Washington Post December 5, 2001  

Bob Jensen

-----Original Message-----
From: Raney, Marc
Sent: Friday, April 16, 2004 4:23 PM
Jensen, Robert
Subject: RE: How Enron Did It


Bill Powers, Dean of the University of Texas Law School, was a keynote speaker at a professional conference I attended a couple of weeks ago in Houston.  His topic was ethics, and he spoke mostly about his experience investigating the Enron situation for their board, which you recall he was asked to join the board to do.  Very interesting presentation and I recommend it if you or any of your students ever have the opportunity to hear it. Powers is a seasoned law professor as well as dean, and is good at reducing the complex to the understandable for the benefit of us non-accountants, thank goodness.  But I think you pros would find it interesting as well. There must be a tape of the presentation floating around somewhere, as I’m sure he’s given the same talk several times. 


"Do female execs have cleaner hands?" by Stacy Teicher (Stanford University), Christian Science Monitor, March 15, 2004 --- 
Evidence suggests a link between women and ethical behavior. But they embezzle more often. In a post-Martha Stewart world, corporate America sifts conflicting claims. By Stacy A. Teicher | Staff writer of The Christian Science Monitor

Not long ago, it was the year of the whistle-blowing women - with Sherron Watkins of Enron, Cynthia Cooper of WorldCom, and Coleen Rowley of the FBI being celebrated on the cover of Time magazine. It was tempting to speculate that if more women were in charge, they'd be an ethical force capable of transforming top management.

But more recent criminal cases, against Martha Stewart and Enron's Lea Fastow, have tempered those hopes. Clearly businesswomen can cross ethical and legal lines right alongside the men.

So where should corporate America turn in a post-Martha world? As more women move into boardrooms and corner offices, can they have a cleansing effect?

Welcome to a contentious debate with plenty of ifs and buts - and few hard facts.

There is some evidence suggesting a tantalizing link between women and ethical business behavior. But not everyone buys it - and even those who do often disagree as to why.

"There's a camp that argues women are going to bring a different perspective based on their historically and culturally accepted caretaking roles," says Debra Meyerson, professor of education and organizational behavior at Stanford University. "And there's another perspective that doesn't buy into this [argument] that women and men are different in some fundamental way."

Many tread carefully somewhere in between. Advocates for appointing more women to corporate boards of directors say it would lead to better business practices - but not because women are inherently more ethical. "Because [women] have been outside [most corporate boards] for so long, as individuals they're bringing a new perspective. They're not necessarily just going to be one of the Greek chorus saying 'yes' to the CEO," says Toni Wolfman, chair of the corporate-board resource committee at The Boston Club, a professional women's group.

A 2002 Canadian study offers a rare glimpse beyond the anecdotes that are a staple of this debate. It found that 94 percent of corporate boards with three or more women ensured that their companies had conflict-of-interest guidelines, compared with 68 percent of all-male boards. When it came to verifying audit information, the figures were 91 percent vs. 74 percent, according to the Conference Board of Canada, an independent research group. The study doesn't claim a causal link, however, since it's possible that companies already engaging in such practices attract more women to their boards.

About 16 percent of board members in Canada are women. In Fortune 500 companies in the United States, it's about 14 percent. What's noteworthy about the Canadian study, Professor Meyerson says, is that it looked at boards with more than two women. Research has shown that unless a minority group reaches a tipping point of about 15 percent representation, its members are under extreme pressure to conform to the majority. Women who have served on boards confirm that finding, saying men show greater respect for their views as individuals when there is more than just a token woman present.

"We're not asking you to put them on [boards] because they're women, [but] if you're looking for the best directors, you can't afford to ignore half the universe," Ms. Wolfman says.

Embezzlement factor As more women reach positions of power in the business world, some observers say, there will simply be equal opportunity for corruption.

Embezzlement statistics bolster this argument. In 2002, women committed slightly more embezzlement crimes than men. A recent New York Times analysis of federal data showed that between 1993 and 2002, embezzlement by women increased 80.5 percent to 5,917 (compared with 5,898 by men).

In the broader category of occupational fraud and abuse, men do commit 75 percent of the crimes, and they steal larger amounts of money - a median of $185,000 compared with $48,000 for women, according to a 2002 report by the Association of Certified Fraud Examiners. That's because more men hold high-level positions where they can manipulate financial statements, argues Kyle Anne Midkiff, a certified fraud examiner and principal at Nihill & Riedley, P.C. in Philadelphia.

Continued in the article

Are women more ethical and moral? --- 


Mr. Brown said the dispute with the auditor about disclosing the borrowings occurred in March 2001 as the company and Deloitte were preparing Adelphia's 2000 annual report. Deloitte issued a clean audit opinion in that report. He said he was able to convince the Deloitte auditor not to disclose the total amount the Rigases had borrowed, but to disclose only the amount the Rigases could borrow under the arrangement. "I didn't want the public to know how much the Rigases had borrowed because I thought there would be significant negative ramifications," Mr. Brown said. He testified that Timothy Rigas told him "we should give up on other points if we have to, but that's the last point we want to give up on with the auditors."
Christine Nuzum (see below)


"Adelphia Auditor Was Pressured Not to Disclose Debt Levels in '01," by Christine Nuzum, The Wall Street Journal, May 7, 2004, Page C3 ---,,SB108387463532904274,00.html?mod=technology_main_whats_news

Deloitte & Touche, the former auditor for Adelphia Communications Corp., wanted the cable company to disclose the total amount of debt held by the Rigas family and guaranteed by Adelphia in 2001, but backed off under pressure from company executives.

A year later, when the company revealed that the family that controlled Adelphia had borrowed close to $2.3 billion, it triggered the accounting scandal that led the Rigases to resign and the company to file for bankruptcy protection.

Testifying in federal court yesterday, Adelphia's former vice president of finance, James R. Brown, said even when the company did make the disclosure about the Rigas borrowings in early 2002, it understated the debt by more than $250 million. Mr. Brown said the company determined Adelphia had guaranteed $2.55 billion in Rigas family debt as of the end of 2001, and that roughly $1.3 billion had been used to buy securities. He said he and Timothy Rigas discussed "ways to represent the $2.5 billion as a lower number and the $1.3 billion as a lower number," Mr. Brown said.

Mr. Brown said the dispute with the auditor about disclosing the borrowings occurred in March 2001 as the company and Deloitte were preparing Adelphia's 2000 annual report. Deloitte issued a clean audit opinion in that report. He said he was able to convince the Deloitte auditor not to disclose the total amount the Rigases had borrowed, but to disclose only the amount the Rigases could borrow under the arrangement.

"I didn't want the public to know how much the Rigases had borrowed because I thought there would be significant negative ramifications," Mr. Brown said. He testified that Timothy Rigas told him "we should give up on other points if we have to, but that's the last point we want to give up on with the auditors."

Deborah Harrington, a spokesman for Deloitte, said, "We don't intend to comment on the trial."

Adelphia founder John Rigas, his sons Timothy and Michael, and former assistant treasurer Michael Mulcahey are on trial in New York on charges of conspiracy and fraud. They are accused of using Adelphia as a "personal piggy bank" for the Rigas family and misleading investors, creditors and the public about Adelphia's finances and operations. Mr. Brown, the government's star witness, has pleaded guilty in the case and is testifying in the hope of receiving a lighter sentence.

Continued in article

Bob Jensen's threads on the Deloitte & Touche are at 

"Adelphia's 'Accounting Magic' Fooled Auditors, Witness Says<" by Christine Nuzum, The Wall Street Journal, May 5, 2004 ---,,SB108369959478101710,00.html?mod=technology_main_whats_news 

Adelphia Communications Corp. revealed its real results and its publicly reported inflated numbers in the books given to many employees, including founder John Rigas and two of his sons, a former executive testified.

But these financial statements, detailing actual numbers and phony ones dating back to 1997, weren't disclosed to the company's auditors, Deloitte & Touche, said former Vice President of Finance James Brown in his second day on the stand. Former Chief Financial Officer Timothy Rigas supported the system to keep employees aware of the company's real performance, Mr. Brown testified.

For example, one internal document showed that while Adelphia's operating cash flow was $177 million for the quarter ended in September 1997, its publicly reported operating cash flow was $228 million, Mr. Brown said.

Mr. Brown has pleaded guilty in the case and is testifying in hopes of receiving a reduced sentence.

John Rigas, his sons Timothy Rigas and former Executive Vice President Michael Rigas, and former Assistant Treasurer Michael Mulcahey are on trial here on charges of conspiracy and fraud. Michael Rigas was back in court yesterday, one day after court was canceled due to a medical issue that sent him to the hospital over the weekend. People close to the case said the problem was minor.

Mr. Brown said he devised various schemes to inflate Adelphia's publicly reported financial measures. Company executives were afraid that if Adelphia's true performance was revealed, the company would be found in default of credit agreements, he said. "I used the term 'accounting magic,' " Mr. Brown said.

In March 2001, phony documents dated 1999 and 2000 were created "to fool the auditors into believing that they were real economic transactions," he testified.

Mr. Brown discussed the details of how to inflate Adelphia's financial measures with Timothy Rigas more than the other defendants, but John Rigas and Michael Rigas also knew that the company's public filings didn't represent its real performance, he testified. John Rigas occasionally showed discomfort with the inflation, but did nothing to stop it, Mr. Brown said.

Mr. Brown testified he used to regularly tell John Rigas Adelphia's real results and how they compared with those of other cable companies. "On one occasion John told me, 'We need to get away from this accounting magic,' " he recalled. Mr. Brown added that he understood that to mean that Adelphia needed to boost its operations so that at some point in the future, the inflation could stop.

In another discussion about inflated numbers in early 2001, John Rigas "told me he felt sorry for Tim Rigas and me because the operating results were putting so much pressure on us ... but he said, 'You have to do what you have to do,' " Mr. Brown testified. "He also said we can't afford to have a default." Mr. Brown said he took that to mean that reporting inflated numbers was preferable to defaulting.

Bob Jensen's threads on the Deloitte & Touche are at 

From the SEC on June 9, 2004 --- 

SEC Settles Securities Fraud Case with i2 Technologies, Inc. Involving Misstatement of Approximately $1 Billion in Revenues

i2 Will Pay a $10 Million Civil Penalty

The Securities and Exchange Commission today announced a settled enforcement action against i2 Technologies, Inc. ("i2") in connection with alleged accounting improprieties and misleading revenue recognition by the Dallas-based developer and marketer of enterprise supply chain software and management solutions. i2 agreed to pay a $10 million civil penalty and nominal $1 disgorgement in a civil suit the Commission filed in the United States District Court for the Northern District of Texas (Dallas Division). As part of the settlement, but without admitting or denying the Commission's substantive findings or allegations, i2 consented to the entry of a cease-and-desist order finding that i2 committed securities fraud in accounting for certain software license agreements and in accounting for and improperly disclosing four "barter" transactions. As provided under the Sarbanes-Oxley Act of 2002, the penalty amount will become part of a disgorgement fund for the benefit of injured i2 investors.

In summary, the Commission's cease-and-desist order finds and civil complaint alleges that, for the four years ended December 31, 2001 and the first three quarters of 2002, i2 misstated approximately $1 billion of software license revenues. As a result, i2's periodic filings with the Commission and earnings releases during this period materially misrepresented i2's revenues and earnings.

Specifically, the order finds and complaint alleges that i2 favored up-front recognition of software license revenues, purportedly in accordance with generally accepted accounting principals ("GAAP"). i2's compensation structure fostered this preference, because compensation of sales and pre-sales personnel was largely based on the amount of revenue recognized and cash collected in the current period. However, as i2 knew or recklessly ignored, immediate recognition of revenue was inappropriate for some of i2's software licenses because they required lengthy and intense implementation and customization efforts to meet customer needs. In some cases, i2 shipped certain products and product lines that lacked functionality essential to commercial use by a broad range of users. In other cases, the company licensed certain software that required additional functionality to be usable by particular customers. On still other occasions, i2 exaggerated certain product capabilities, or entered into side agreements with certain customers that were not properly reflected in the accounting for those transactions. In each case, significant modification and customization efforts were necessary to provide the required functionality.

i2 also improperly recorded revenue from four barter transactions during the restatement period. These transactions involved third-party purchases of software licenses from i2, with i2 recognizing the revenue immediately, in exchange for i2's agreement to purchase from the other parties in the future a comparable amount of products or services. In some of these transactions, i2 paid a premium over the prevailing rates for those products or services, in an effort to equalize both sides of the deal. When i2 recorded revenue from these transactions, it could not determine the fair value of the items exchanged within reasonable limits. Accordingly, i2's up-front recognition of license revenue from these transactions was improper under GAAP. Moreover, i2's financial statements and Commission filings failed to disclose the true nature of these transactions, which improperly inflated i2's reported revenues by approximately $44 million.

The Commission also found and alleges that, during the summer of 2001, i2 received two documents flagging issues impacting software license revenue recognition. First, in June 2001, i2 generated a summary of revenue recognition risks, outlining such potential problems as identifying products to meet customer needs after licenses were signed; bundling wrong or incorrectly positioned products in deals; substantial underestimation of implementation services necessary to meet customer needs; the provision of development and customization services without separate formal agreements; and barter transactions.

Second, also in June 2001, i2 received the initial report of a Massachusetts Institute of Technology professor the company had hired to examine its business practices. The professor's report identified serious deficiencies within the organization, from shortcomings in its product and technology strategy to weaknesses in its sales practices, product release management, and quality assurance. Critically, this report indicated that i2's products had largely become "custom" software requiring considerable customization and modification, which would preclude up-front recognition of revenue from these licenses. Neither i2's auditors nor Audit Committee learned of the MIT professor's report until September 2002.

Continued in the report.

The company's homepage is at 


The company is audited by Deloitte and Touche.  Updates on Deloitte and Touch auditing mishaps can be found at 


Arizona State University Receives Multi-million Dollar Supply Chain Software Donation from i2 --- 


Bob Jensen's threads on revenue accounting are at 

What Matters Most-How A Small Group Of Pioneers Is Teaching Social Responsibility To Big Business, And Why Big Business Is Listening
by Jeffrey Hollender and Stephen Fenichell
ISBN: 0-7382-0902-3

Sarbanes-Oxley Reference Articles --- 

From Deloitte and Touche
Audit Committee Brief: January 2004 --- 
Issue Number
January 2004

Review key regulatory, technical and professional developments in corporate governance and accounting in our quarterly newsletter, Audit Committee Brief. In the newsletter, we include links to related information on many topics. The January 2004 edition includes:

  • An overview of the new NYSE and NASDAQ Corporate Governance Listing Standards
  • Information on the AICPA's recently published Audit Committee Toolkit
  • An overview of our recently issued booklet: Pension Accounting: An Executive Guide to the Fundamentals and the Changing Landscape
  • A summary of the PCAOB's proposed auditing standard addressing the Sarbanes-Oxley Act Section 404 attestation
  • An introduction to Meeting the Street: A Discussion of Earnings and Other Guidance Provided to Investors, which we recently published in conjunction with Financial Executive Research Foundation
  • A discussion regarding emerging practices in board education
  • Legislative and regulatory highlights and outlook
  • Highlights from the AICPA conference on current SEC developments
  • Overview of new items posted to Audit Committee Online
  • Links to our technical update newsletters, Accounting Roundup and EITF Roundup

Find the complete January 2004 issue of Audit Committee Brief in the PDF attachment below. Or visit our Audit Committee Brief Archive, where you can access past issues.

Audit Committee Brief (319 KB)
January 2004 Newsletter


"Emerging from Bankruptcy, WorldCom Faces $1B Tax Bill, AccountingWEB, April 20, 2004 --- 

As WorldCom is about to emerge from the biggest bankruptcy in U.S. history, its former home state claims it owes $1 billion in back taxes. 

Reuters reported that more than 12 states have made $500 million in claims against the bankrupt phone company. The states also filed a motion to have KPMG removed as WorldCom’s auditor. Mississippi’s $1 billion claim came to light Friday when the U.S. bankruptcy court judge heard arguments on the states’ KPMG motion.

Continued in the article

Bob Jensen's threads on the Worldcom scandal are at 

Bob Jensen's threads on KPMG's legal woes are at

"Vendors hawk Sarbanes-Oxley wares," by Ann Bednars, NetworkWorldFusion --- 

Like tax accountants in April, software vendors are lining up to help companies comply with regulatory issues set forth in the Sarbanes-Oxley Act of 2002IBMOracle  and SAP are among the latest to unveil new and upgraded products designed to make it easier for companies to put in place internal processes and systems that will help them meet the requirements of the law.

Other vendors are listed in this article.

Whistle-Blower Woes
"Many companies think the whistle-blower provisions of Sarbanes-Oxley will spark nuisance suits by disgruntled employees. The truth is far more complex," by Alix Nyberg, CFO Magazine, October 01, 2003 ---,5309,10790||BS||181,00.html?f=insidecfo 

When Matthew Whitley was laid off from his job last March as a finance manager at The Coca-Cola Co., along with about 1,000 other employees, he didn't take it lying down. Two months later, Whitley approached his former employer seeking a whopping settlement—$44.4 million—on the grounds that he had been fired in retaliation for raising concerns about accounting fraud. When Coke balked, Whitley turned for relief to a new ally: the Sarbanes-Oxley Act of 2002. He filed for whistle-blower protection under the act's Section 806 provisions, and initiated federal and state lawsuits that charged seven Coke executives, including CFO Gary Fayard, with crimes ranging from racketeering to mail and wire fraud.

"This disgruntled former employee has made a number of allegations accompanied by an ultimatum: that the company pay him almost $45 million or he would go to the media," said Coke in a May statement announcing the claims. Since then, a Georgia state court judge has dismissed most of the charges, including those related to racketeering and breaches of fiduciary responsibility. While Coke may still have to defend itself against claims related to wrongful termination, "we are confident we will prevail once the facts are presented in a court of law," said Coke in a statement.

One of Whitley's allegations, however, has already had some effect. His contention that Coke falsified a marketing test of Frozen Coke at Burger King restaurants in Virginia led the company to make a public apology and an offer to pay Burger King $21 million. In July, the Department of Justice (DoJ) announced it was launching a criminal investigation of the alleged fraud.

CFOs may be forgiven for fearing that cases like Whitley's are a harbinger of things to come—that, thanks to the protections afforded by Sarbanes-Oxley, irate workers will accuse their employers of financial wrongdoing in order to wring large settlements from them. Indeed, on August 27, a federal judge refused to dismiss a whistle-blower lawsuit accusing TXU Corp., an energy company, of earnings manipulation; unless the case is settled, it will become the second suit filed under Section 806 to reach a federal court (the first involved JDS Uniphase Corp.).

But it remains to be seen whether Sarbanes-Oxley will have a significant impact on whistle-blower litigation. Although the number of such filings has increased, most will probably be dismissed as lacking merit. And even with the new protections of Section 806, would-be whistle-blowers still face a painful cost-benefit decision: whether a lawsuit with uncertain chances of success is worth the professional and personal sacrifices that will assuredly be required.

Continued in the article

Bob Jensen's threads on proposed reforms are at 

Bob Jensen's threads on whistle blowing are at 

Surprise! Surprise!

Audits of corporations continue to drop, despite the Bush administration's hard line on tax cheats, a study released this week shows. IRS officials don't dispute the findings, but said the report didn't tell the whole story.

"Big Corporations Escape IRS Scrutiny, Audits Drop," AccountingWEB, April 13, 2004 --- 

Audits of corporations continue to drop, despite the Bush administration’s hard line on tax cheats, a study released Monday shows.

The Internal Revenue Service conducted face-to-face audits on only 29 percent of the largest corporations in 2003, compared with 34.7 percent in 1999. In looking at all corporations, big or small, face-to-face audits dropped to 7 percent in 2003 from 15 percent in 1999, according to the Transactional Records Access Clearinghouse, a research organization associated with Syracuse University.

IRS officials didn't dispute the findings, but said the report didn’t tell the whole story, the Wall Street Journal reported. The figures are for completed audits, so the report doesn’t reflect the new tax shelter investigations under way, IRS officials said. Tight enforcement budgets have also hindered the agency’s efforts.

"There's been a lag" in the corporate-enforcement turnaround, said IRS Commissioner Mark Everson. "Our expectations are we're turning that corner now, and the decrease has stabilized in '04. ... This is the hinge year we're in."

IRS officials predict corporate audit rates for medium-size companies will jump from a projected 7.5 percent this year to 13 percent in 2007. For larger corporations, the audit rate should rise to 30 percent from 26 percent over the same time period.

One area where enforcement has begun to turn around is in audits, collections and penalties against individuals. The IRS said in a statement Friday that audits of taxpayers who earn $100,000 or more were up 52 percent from two years ago.

In fact, the IRS said Friday that it plans to inspect corporate executives' tax returns at twice the current rate, including a hard look at corporate perks, such as stock options, private jets and luxury apartments.

The IRS last year audited 24 major corporations in a sampling of industries and locations to see if they were following the rules when paying their executives. That study led agents to look into tax returns filed by some corporate leaders. Their discovery? Some hadn't filed returns at all.

Oversight will increase over executive stock options, business and personal use of fringe benefits, improper use of family limited partnerships, "golden parachute" benefit packages, life insurance misused as a vehicle to transfer wealth, offshore employee leasing practices that improperly hide money abroad and deferred compensation agreements.

Bob Jensen's threads on why the amount of revenue collected from the U.S. corporate income tax code is shrinking to where the cost of collecting it in society is nearly more than the amount collected are at 

E&Y Suspended for Lack of Auditor Independence

"Ernst & Young Gets SEC Penalty For Ties to Client," by Jonathan Weil, The Wall Street Journal, April 19, 2004 ---,,SB108214408244385161,00.html?mod=home_whats_news_us

In one of the longest suspensions ever of a major accounting firm, Ernst & Young LLP was barred for six months from accepting any new audit clients among publicly traded companies as punishment for participating in a lucrative business venture with a company whose books it audited.

The ruling Friday by the Securities and Exchange Commission's chief administrative-law judge marks the latest sanction of an accounting firm for violating the agency's auditor-independence rules, which are intended to ensure that accounting firms remain impartial in their evaluations of corporate clients' financial statements. The suspension applies to American or foreign companies whose stock or debt trades on U.S. markets.

Ernst had fiercely contested the SEC enforcement division's allegations that it compromised its independence by engaging in a joint venture with PeopleSoft Inc. at the same time that it was the software maker's outside auditor, at one point calling the allegations "outrageous." On Friday, Ernst, the nation's third-largest accounting firm, said it wouldn't appeal the decision.

The conduct occurred in the 1990s, at a time when accounting firms' fees weren't disclosed and the prevailing culture within the major firms was to use audits as a loss leader to generate other, more-lucrative business with clients.

Three of the four major accounting firms, including Ernst, since have sold their consulting practices in response to pressure from regulators. Only Deloitte & Touche LLP continues to maintain a sizable consulting practice, though it too has come under pressure to part ways with its consulting business. Nowadays, companies with publicly traded securities must disclose how much they pay their independent accounting firms for audit and nonaudit work.

Continued in the article

"Big Auditing Firm Gets 6-Month Ban on New Business," by Floyd Morris, The New York Times, April 17, 2004 --- 

Ernst & Young, the big accounting firm, was barred yesterday from accepting any new audit clients in the United States for six months after a judge found that the firm acted improperly by auditing a company with which it had a highly profitable business relationship.

The unusual order, which included a $1.7 million fine, brought to an end a bitter fight in which the Securities and Exchange Commission had contended that Ernst violated rules on auditor independence by jointly marketing consulting and tax services with an audit client, PeopleSoft Inc.

The overwhelming evidence," wrote Brenda P. Murray, the chief administrative law judge at the S.E.C., is that Ernst's "day-to-day operations were profit-driven and ignored considerations of auditor independence." She said the firm "committed repeated violations of the auditor independence standards by conduct that was reckless, highly unreasonable and negligent."

The rebuke to Ernst, which said it would not appeal the decision, is the latest embarrassment for one of the Big Four accounting firms, which have come under heavy criticism and increased regulation as a result of accounting scandals in recent years. Those scandals led to the demise of Arthur Andersen, which had formerly been among the Big Five.

The judge was harshly critical of the Ernst partner who was in charge of independence issues, saying he kept no written records and had failed to learn enough facts before saying the relationships between Ernst and PeopleSoft were proper. That partner, Edmund Coulson, was chief accountant of the S.E.C. before he joined Ernst in 1991.

Ernst's consulting and tax practices used PeopleSoft software in their business, and the two companies participated in some joint promotion activities. Ernst contended that it should be viewed as a customer of PeopleSoft in the relationship, but the judge said it went far beyond that.

She noted that Ernst had billed itself in marketing materials as an "implementation partner" of PeopleSoft and had earned $500 million over five years from installing PeopleSoft programs at other companies, which use the software to manage payroll, human resources and accounting operations.

She issued a cease-and-desist order against the firm, saying it had refused to admit it had done anything wrong and that there was no reason to believe it would not violate the rules again. She also fined it $1,686,500, the total amount of audit fees the company received from PeopleSoft in the years that were involved, plus interest of $729,302, and ordered that an outside monitor be brought in to assure the firm complied with the rules in the future.

S.E.C. officials said the decision would send a message to other firms. "Auditor independence is one of the centerpieces of ensuring the integrity of the audit process," said Paul Berger, an associate director of the commission's enforcement division, adding that the judge's decision "vindicates our view that Ernst & Young engaged in a business relationship that clearly violated" the rules.

Ernst, based in New York, had previously denounced the commission for seeking a ban on new business, saying any such punishment was completely unwarranted. But last night the firm said it would accept the ruling and would not appeal. It had the right to appeal to the full S.E.C. and then to federal courts if the commission ruled against it.

"Independence is the cornerstone of our practice and our obligation to the public," said Charlie Perkins, a spokesman for Ernst & Young. "We are fully committed to working closely with an outside consultant in the review of our independence policies and procedures."

Mr. Perkins said the firm had decided not to appeal because it wanted to put the matter behind it, and emphasized that it would be able to continue serving its existing clients.

The six-month suspension appears to match the longest suspension on signing new business ever imposed on a leading accounting firm.

In 1975, Peat Marwick, a predecessor of KPMG, agreed to accept a similar six-month suspension as part of a settlement of charges it had failed to properly audit five companies, including Penn Central, the railroad that went bankrupt.

Bob Jensen's threads on the legal and ethical woes at Ernst and Young and other large auditing firms are at 

"Mutual-Fund Indictment Against Broker Reveals 'Startling' Phone Dialogue," by Christopher Oster and Carrick Mollenkamp, The Wall Street Journal, April 6, 2004, Page C1 ---,,SB108118385501774428,00.html?mod=home_whats_news_us

New York Attorney General Eliot Spitzer unsealed a criminal indictment against former Bank of America Corp. broker Theodore Sihpol that included previously unreleased recordings of phone conversations that Mr. Spitzer said show Mr. Sihpol and a New Jersey hedge fund scheming to make illegal mutual-fund trades.

Mr. Spitzer called the phone conversations "startling" and said evidence in this and other cases in the works will show market-timers and late-traders were fully aware what they were doing was taboo, if not illegal. More such details will emerge as other cases progress, the attorney general said. "Similar types of subterfuge were employed" in other fund-trading cases, said Mr. Spitzer.

Also yesterday, a top executive at Janus Capital Group Inc., Lars O. Soderberg, was placed on leave in connection with the ongoing mutual-fund-trading investigations.

Mr. Spitzer and the Securities and Exchange Commission filed criminal and civil charges against Mr. Sihpol, formerly a broker in Banc of America Securities' private client group, in September. Yesterday's unsealed criminal indictment lists 40 counts, including grand larceny, fraud and violation of business law. The felonies are punishable by as much as 25 years in prison. Mr. Sihpol, who has denied the charges, was dismissed by the bank after the investigation became public.

Banc of America Securities is a unit of Bank of America, which declined to comment on the indictment. Last month, Bank of America, based in Charlotte, N.C., settled with the attorney general and the SEC for its role in the mutual-fund scandal and agreed to fee reductions, disgorgements, restitution and fines totaling $675 million for the bank and soon-to-be-acquired FleetBoston Financial Corp.

Mr. Spitzer said that he was able to reach a settlement with Bank of America because the bank didn't have knowledge of the type of conversations Mr. Sihpol allegedly had with fund traders and detailed in the indictment. While a few fund companies have settled with regulators, several criminal cases are being pursued, and dozens of fund companies and Wall Street firms have confirmed receiving subpoenas from regulators related to fund trading.

Mr. Sihpol's attorney, Evan Stewart, of Brown Raysman in New York, said the recorded statements "represented in the indictment represent a small fragment of the taped materials that exist. The attorney general's office has yet to make available to the defendant a complete record of those materials. Any tape recordings can be selectively taken out of context and presented in a particular fashion. These do not change Mr. Sihpol's position that he did not engage in criminal wrongdoing."

Three phone conversations between Mr. Sihpol and an unidentified representative of the hedge fund are detailed in a transcript in the grand jury indictment. Two of the conversations appear to show Mr. Sihpol and a representative of the hedge fund, Canary Capital Partners LLC, negotiating the timing of the hedge fund's trading. At first, Canary says it wants to submit its trades at 6 p.m. Eastern time, according to the transcript. At Mr. Sihpol's request, Canary agrees to make the trades by 5 p.m.

Both Mr. Sihpol and Canary said that tickets showing the time of the trades, however, would show they were made before 4 p.m., the indictment shows. In the second conversation, Canary's representative says he can send through a slate of prospective trades by 2 or 2:30 in the afternoon, which could be processed after 4 p.m. if Canary approves the trades. If not, Mr. Sihpol was to "put them in the garbage."

After-hours trading allows an investor to take advantage of news that comes out after the stock market closes -- information that isn't available to investors who buy or sell before 4 p.m. It is illegal.

In an interview, Mr. Spitzer called the Canary arrangement disappointing and criminal. "The notion that documents were being time-stamped to create the possibility of being put through or not put through is brazen," Mr. Spitzer said. He declined to say who from Canary was speaking to Mr. Sihpol.

In March 2003, Canary was using software provided by the bank to place trades on its own, with time-stamped tickets no longer necessary. But Mr. Sihpol, in a conversation with a Canary representative, wanted to make sure the two sides had their stories straight, according to Mr. Spitzer.

"I'm sure you know the right answer, but it came up today in conversation," Mr. Sihpol said in that conversation, according to the indictment transcript. "You guys make all the investment decisions before 4 o'clock, correct?"

The Canary representative replied, "Absolutely" and asked Mr. Sihpol why the issue surfaced. Referring to the software system that allowed Canary to trade funds until 5:30 -- after the normal 4 p.m. cutoff for fund trades -- Mr. Sihpol said another bank employee had concerns about Canary having access to the system. The employee worried, Mr. Sihpol said, about the possibility of Canary being audited.

As for Mr. Soderberg of Janus, the Denver fund company -- one of the original companies implicated in the fund-trading scandal that erupted last summer -- had said in November that the "few employees central" to the decision to accept money from timers had left the company.

Yesterday, however, Janus said that Mr. Soderberg, head of the company's institutional business, had agreed to take a leave of absence and that Janus would "continue to evaluate [Mr.] Soderberg's future role with the Company, in light of the ongoing investigations of the mutual fund industry and related regulatory matters."

Continued in the article

Bob Jensen's threads on the mutual fund scandals are at 

How to Fix Corporate Boards

"Yale Dean Suggests New Debate On How to Fix Corporate Boards," AccountingWEB, April 15, 2004 --- 

One voice is missing from the mix of regulators, attorneys, shareholder activists and business leaders who are trying to fix corporate boards — psychologists.

Jeffrey Sonnenfeld, associate dean at the Yale School of Management, suggests in that psychologists could add information about the "litany of pathologies" on corporate boards, which he lists as "groupthink, bystander apathy, diffusion of responsibility, inconsistent incentives, obedience to authority, atrophy and the like."

Sonnenfeld says that now is the time to move the governance debate away from new procedures and checklists and toward "intelligent thinking about people and their character." With this in mind, he offers advice on selecting directors:

Bob Jensen's threads on corporate governance scandals are at 

How Not to Fix Corporate Boards

The planned deal raised questions about whether the two investors slated to join the board -- David Matlin of MatlinPatterson and Glenn Hutchins of Silver Lake -- had received favorable treatment from MCI. 
"MCI Rescinds Deal With Investors After Criticism," by Mitchell Pacelle and Shawn Young, The Wall Street Journal, April 19, 2004 ---,,SB108232471768285933,00.html?mod=technology_main_whats_news 

MCI, the long-distance phone company scheduled to emerge from bankruptcy this week, has canceled a confidential arrangement it struck with two of its largest investors after other investors called the deal unfair. A judge criticized the company's handling of the arrangement with the two investors, who until last week were expected to join the company's board.

The deal, which had been struck in January, called for the two investment firms, MatlinPatterson Asset Management and Silver Lake Partners, to swap all of their old MCI bonds for new MCI bonds, instead of the mix of new stock and bonds that many other creditors will receive. MCI said the arrangement was intended to preserve a tax benefit for the company potentially valued at as much as $500 million.

But when other creditors learned of the confidential arrangement, some of them objected, arguing that it would have given the two large investors a richer deal than was available to other investors holding the same defaulted bonds. In recent months, as questions mounted about MCI's future, MCI's stock, which has been trading on a when-issued basis, has fallen in value, while the bonds have held up. Moreover, the bonds will be easier to sell in quantity than the new stock, investors said.

The planned deal raised questions about whether the two investors slated to join the board -- David Matlin of MatlinPatterson and Glenn Hutchins of Silver Lake -- had received favorable treatment from MCI. Because of the objections, MCI agreed about one week ago to cancel the agreements with these two investors, who will now be treated the same as other bondholders, according to New York lawyer Marcia Goldstein, who represents MCI and helped negotiate the agreements.

Continued in the article

Bob Jensen's threads on corporate governance scandals are at 

April 15, 2004 message from 

We have posted a new listing of articles which are forthcoming in one or another of the Allied Academies journals. We have been working with many of you to ensure that our queue is correct and that titles, authors, and affiliations are correct. Please note that this list was updated on 3-14-04 and does not reflect any of the more recently accepted articles or the award winners from the New Orleans conference. We hope to institute a new system which will maintain a constant list of approved and forthcoming articles on the web page.

If you have a forthcoming article, please check our listing (see link below) and be sure that your article is listed, and that the titles, authors, and affiliations are correct. If there are any errors, please email  with corrections as soon as possible. 

To those of you who participated in the New Orleans conference, we would like to thank all 225 of you for making it our best conference yet. We hope to have the Newsletter up in the next few weeks and will e-mail it to you then. We hope to have the online system geared up to take Internet Conference submissions and Maui submissions very soon as well. We look forward to your participation. 

Thank you, 

Trey Carland

From The Wall Street Journal Accounting Educators' Review on April 16, 2004

TITLE: Damage Control: Auditors Hope for Liability Victory in U.K. 
REPORTER: David Reilly 
DATE: Apr 13, 2004 
TOPICS: Accounting, Auditing, International Auditing, Legal Liability

SUMMARY: The British Department of Trade and Industry is considering a change that would limit auditor liability in the United Kingdom. If auditor liability is limited in the United Kingdom, other European countries may follow. Questions focus on existing liability regimes and how changes are likely to impact the profession.

1.) What is the standard of care required in the U.S. for audit services provided to public companies? Is this a realistic standard? Support your answer.

2.) What is limited liability? How does limited liability related to joint-and-several liability and separate-and-proportionate liability?

3.) Discuss the advantages and disadvantages of limited liability for the audit profession. Is it conceivable that limited liability would reduce the value of an audit? Support your answer.

4.) What are "deep pockets" ? How does the perception that auditors have deep pockets impact potential audit related litigation? Would limited liability change the "deep pockets" perception? Support your answer.

5.) What defenses are available to the auditor for litigation related to the audit of public companies? Even if the auditor is not found liable by the courts, does audit related litigation negatively impact the audit firm and the audit profession? Support your answer.

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

Bob Jensen's threads on proposed reforms are at 


"Will Skilling's night out cost him?" CNN Money, April 22, 2004 --- 

Prosecutors eye changes to release terms, say former Enron CEO lied to staff about being drunk. April 22, 2004: 2:32 PM EDT

HOUSTON (Reuters) - Prosecutors charged Wednesday that former Enron Chief Executive Jeff Skilling broke the terms of his $5 million bond during a bizarre alcohol-fueled fracas in New York earlier this month.

The court filing says Skilling's blood alcohol level was 0.19 -- more than twice the legal limit for driving in most U.S. states -- when police sent him to the hospital at 4 a.m. on April 9. The case against Skilling does not involve driving, however.

Officers described Skilling as "uncooperative and intoxicated" and deemed him "an emotionally disturbed person" because he was accusing bar patrons of being undercover agents for the Federal Bureau of Investigation.

"At one point, Skilling went to the middle of the street, put his hands behind his back and began talking to the sky, asking if FBI cameras were capturing what was happening," the motion says.

The motion stops short of asking U.S. District Court Judge Sim Lake to revoke Skilling's bond, and instead asks for a hearing to discuss changes to his terms of release.

He was freed Feb. 19 after pleading not guilty to 35 counts of fraud, insider trading and lying about Enron's finances.

Skilling's attorney, Daniel Petrocelli, said his client regrets the incident.

Bob Jensen's threads on the Enron/Andersen Scandals are at 

"AOL may face SEC accusations"
Report: Time Warner unit under scrutiny for $400 million in ad bookings. 
CNN Money --- 
April 13, 2004: 1:00 PM EDT

The Securities and Exchange Commission is preparing to formally accuse Time Warner Inc. of improperly booking more than $400 million in advertising revenue, The Washington Post reported Tuesday.

The case alleges that Time Warner and its America Online unit misled investors about the financial health of AOL by pumping up ad revenue in numerous deals, and by inflating AOL subscriber numbers, the newspaper said.

Citing federal sources, the newspaper said the improperly booked revenue related mainly to an ad deal with German media company Bertelsmann AG following Time Warner's 2001 merger with America Online Inc.

AOL Time Warner, as the company was known until late last year, booked as revenue a $400 million payment from Bertelsmann to America Online for advertising, close to the time it purchased the German company's interest in AOL Europe. The SEC said part of the sum should be recorded as a discount to AOL Time Warner for the purchase.

The SEC plans to send a formal letter of notification to Time Warner by early summer, according to the newspaper.

The Post said Bertelsmann is part of a broader case that SEC officials are putting together.

In the fall of 2002, Time Warner restated $190 million in revenue from a few AOL advertising deals affecting the 2000-2002 period.

The Post quoted people familiar with the case as saying that the SEC has identified numerous other transactions that require additional restatements.

The SEC is also considering seeking financial sanctions against Time Warner for not cooperating sufficiently with the investigation, the Post reported, citing people familiar with the probe.

The company told CNN/Money that it will continue to cooperate with the SEC and DOJ investigations.

"The company intends to continue its efforts to cooperate with both the SEC and the DOJ investigations to resolve these matters," said Tricia Primrose, spokeswoman for Time Warner.

Bob Jensen's threads on revenue accounting are at 

"Continuing Dangers of Disinformation in Corporate Accounting Reports," by Edward J. Kane, NBER Working Paper No. W9634 --- 


Abstract: Insiders can artificially deflect the market prices of financial instruments from their full-information or 'inside value' by issuing deceptive accounting reports. Incentive support for disinformational activity comes through forms of compensation that allow corporate insiders to profit extravagantly from temporary boosts in a firm's accounting condition or performance. In principle, outside auditing firms and other watchdog institutions help outside investors to identify and ignore disinformation. In practice, accountants can and do earn substantial profits from credentialling loophole-ridden measurement principles that conceal adverse developments from outside stakeholders. Although the Sarbanes-Oxley Act now requires top corporate officials to affirm the essential economic accuracy of any data their firms publish, officials of outside auditing firms are not obliged to express reservations they may have about the fundamental accuracy of the reports they audit. This asymmetry in obligations permits auditing firms to continue to be compensated for knowingly and willfully certifying valuation and itemization rules that generate misleading reports without fully exposing themselves to penalties their clients face for hiding adverse information. It is ironic that what are called accounting 'ethics' fail to embrace the profession's common-law duty of assuring the economic meaningfulness of the statements that clients pay it to endorse.

And she lost a mere $25 billion in a derivatives when she was hedging.

"Fannie Mae Used Disputed Methods To Adjust Results," James R. Hagerty, The Wall Street Journal, April 6, 2004, Page A4 ---,,SB108120227130174705,00.html?mod=home%5Fwhats%5Fnews%5Fus 

Fannie Mae has relied heavily on legal but misleading methods to smooth out its reported earnings, the Center for Financial Research & Analysis says.

The findings were presented yesterday by John Barnett, a senior analyst at the Rockville, Md., research firm, majority-owned by TA Associates, a Boston-based private equity firm. Mr. Barnett spoke at a seminar sponsored by the American Enterprise Institute, a conservative think tank and frequent critic of Fannie and its smaller rival, Freddie Mac. The two giant government-sponsored companies buy home mortgages from banks, providing the banks more money to make new loans.

Freddie acknowledged last year that it had manipulated its accounting to make earnings look less volatile. Last week, the two companies' regulator, the Office of Federal Housing Enterprise Oversight, or Ofheo, said its current examination of Fannie's accounting has turned up possible problems that could lead to a restatement of earnings at that company.

One area of concern is how Fannie deals with big fluctuations in interest rates. When interest rates fall, for instance, many mortgage borrowers prepay their loans to refinance on more attractive terms. That forces Fannie to adjust its borrowings to keep the average term of its liabilities roughly in line with that of its assets.

One way Fannie adjusts is to repay some of its debt early, which often produces a loss because investors must be compensated. Another method is to adjust the portfolio of derivative contracts Fannie uses to hedge interest-rate risk. Mr. Barnett said the company has favored the latter method in recent years because that allows it to stretch out any losses from interest-rate movements over a number of years rather than immediately taking a big hit to earnings.

A Fannie Mae spokesman declined to comment. But Fannie has long said that it uses the most efficient means to adjust its portfolio and that those methods aren't designed to mislead investors.

Mr. Barnett also argued that Fannie hasn't taken deep enough write-downs to adjust for the deterioration of its $8 billion of securities backed by manufactured-housing loans. Ofheo, the regulator, last week said the company "may not have applied the proper accounting guidance" in deciding how much to write down assets that have been "impaired."

Over the past few years, defaults on the loans backing manufactured-housing securities have soared, and downgrades by rating agencies have lowered many of the securities to junk status. Fannie has made $206 million of write-downs on its manufactured-housing securities, or about 2.5% of the total value. By contrast, when the Federal Home Loan Bank of New York sold a $1 billion portfolio of similar securities last year, it recorded a loss of 18% on that investment. The home-loan bank's loss was especially severe because it sold at a time of severe weakness in the market. Even so, Mr. Barnett argues that the hits taken by the home-loan bank and other investors suggest Fannie needs to make bigger write-downs.

Fannie has defended its methodology for valuing the securities. In a recent filing with the Securities and Exchange Commission, Fannie said it might be necessary to take further write-downs on the securities but that it believed any such write-downs wouldn't have "a material adverse effect" on operating results.

Jonathan E. Gray, an analyst at Sanford C. Bernstein & Co. in New York who owns Fannie shares, accused Ofheo of scare-mongering and said the agency should present any evidence it has that Fannie's accounting was improper.

Bob Jensen's threads on Fannie and her son Freddie are at 

"Fannie Mae Seeks SEC Support For a Policy Questioned by Ofheo," by James R. Hagerty and Dawn Kopecki, The Wall Street Journal, May 6, 2004, Page A6 ---,,SB108380924614103681,00.html?mod=home%5Fwhats%5Fnews%5Fus 

Fannie Mae is trying to win support from the Securities and Exchange Commission for an accounting policy being questioned by the mortgage-finance company's regulator, according to people familiar with the matter.

The SEC's response to Fannie may determine whether the company will be forced to restate past results, an embarrassing move that could further rattle investors in Fannie's stock and bonds and raise new concerns in Congress about regulation of the company.

The Office of Federal Housing Enterprise Oversight, or Ofheo, which regulates Fannie and its smaller rival, Freddie Mac, has been investigating Fannie's accounting for months. The agency recently said Fannie "may not have applied the proper accounting guidance" in deciding how much to write down the value of securities backed by manufactured-housing loans and certain other assets on its books.

A person who was briefed on progress in the inquiry says he believes it hinges on whether Fannie believes the SEC would be more likely to back Fannie's interpretation of the relevant accounting rules or Ofheo's view. If Fannie believes the SEC will back Ofheo, the company is likely to settle the case and agree to a restatement, this person said. But if Fannie thinks its interpretation is likely to win SEC backing, the company is more likely to fight Ofheo, in court if necessary, he said.

A Fannie spokesman declined to comment on the company's strategy in dealing with the investigation but said Fannie is "cooperating fully." A spokeswoman for Ofheo said she couldn't comment on specifics of the investigation. An SEC spokesman declined to comment.

Ofheo has engaged a team of accountants from Deloitte & Touche LLP to help it with the investigation. Fannie is drawing on advice from two other Big Four accounting firms, KPMG LLP, the company's regular auditor, and Ernst & Young LLP. Fannie also is represented in this matter by the law firm Wilmer Cutler Pickering LLC, known for its securities-law expertise and close contacts at the SEC. One of Wilmer's partners, William R. McLucas, is a former SEC enforcement chief.

One of the main items of contention is whether Fannie should have applied to some of the securities on its books an accounting rule known as EITF 99-20, created by the Financial Accounting Standards Board's Emerging Issues Task Force, or EITF. Rule 99-20, which took effect in 2001, states the conditions under which companies must write down the value of certain types of securities in their portfolios.

Accounting methods at both Fannie and Freddie have been under scrutiny since Freddie admitted last year that it had manipulated its accounting to make its earnings appear less volatile.

FANNIE REACHED an accord with the SEC that will let her avoid restating results but require it to change accounting methods.  . Fannie lost $25 billion in derivatives over a four year period. So many people just do not realize that hedging for fair value creates cash flow risk.  See 

"Fannie to Avoid Restating Results After SEC Accord," by James R. Hagerty, The Wall Street Journal, May 10, 2004, Page A2 --- 

Fannie Mae reached an accord with the Securities and Exchange Commission that will allow the mortgage-finance company to avoid restating results.

The compromise will require Fannie to adopt a new method of accounting for certain securities backed by manufactured-housing loans and aircraft leases -- a demand made last week by Fannie's regulator, the Office of Federal Housing Enterprise Oversight, or Ofheo.

While Fannie will avoid the embarrassment of a restatement, Ofheo will force the company to adopt the new method in future earnings statements. That may lead to more frequent write-downs of such securities in its portfolio. "We won't allow an accounting interpretation that fails to recognize hundreds of millions of dollars in losses," Corinne Russell, Ofheo's chief spokeswoman, said late yesterday.

A Fannie spokesman refused to comment. An SEC representative also declined to comment.

At issue are Fannie's $8 billion of securities backed by manufactured-housing loans and $300 million of securities backed by aircraft leases. The manufactured-housing securities have lost value because of a surge in defaults by buyers of mobile homes. So far, Fannie has written down those securities by about $217 million, but some analysts say far bigger write-downs would be in order.

The SEC is expected to provide Fannie with a letter saying that its old method of deciding how far to write down the securities was consistent with generally accepted accounting principles. That may help Fannie fend off shareholder suits. But Ofheo will be able to say that the method it favors is the best practice and that the old method was misleading.

The dispute involves an accounting rule known as EITF 99-20, which took effect in 2001. The rule states the conditions under which companies must write down the value of certain types of securities. In the past, Fannie appears to have concluded that 99-20 didn't apply to the securities in question and to have used an accounting rule that allows more managerial judgment in determining the amount of write-downs needed. The compromise doesn't end the uncertainty for Fannie, however, because Ofheo continues to examine other aspects of the company's accounting practices.

Fannie and its smaller mortgage-finance rival, Freddie Mac, have come in for heavy criticism in recent months as the Bush administration pushes for legislation that would impose tougher regulation on the two government-sponsored enterprises, or GSEs. Fannie and Freddie borrow in the government-agency bond market and use the proceeds to buy home mortgages from banks and other lenders.

Last week, William Poole, president of the Federal Reserve Bank of St. Louis, warned that investors may be ignoring the potential dangers connected with the companies' debts. While stressing that "on the basis of information I have, no crisis is at hand" at the two GSEs, Mr. Poole said they rely on short-term debt to fund more than a third of the mortgages they hold. The risk is that a surge in interest rates could leave their cost of funding above their interest income from mortgages -- the trap that destroyed many U.S. savings and loan institutions in the 1980s.

Fannie and Freddie hedge against such dangers by purchasing swaps, options and other derivatives, financial contracts designed to parcel out risks to other parties. For instance, they can swap a promise to pay interest at a fixed rate during a certain period to another party, which in turn pays them interest floating at a given margin over a benchmark rate. That way, if a general rise in interest rates pushes up the GSEs' borrowing costs, they can expect an offsetting rise in the floating-rate interest income they receive through the swaps.

If investors lost confidence in GSE debt, however, the companies would have to pay higher interest on new borrowings relative to market benchmarks, Mr. Poole said. In that case, the swaps might no longer provide enough income to make up for the jump in the GSEs' borrowing costs.

A loss of confidence in Fannie and Freddie debt also might make it prohibitively expensive for them to raise new funds. In a typical week, Mr. Poole said, Fannie and Freddie need to raise roughly $30 billion in new short-term debt to pay off obligations coming due. To reduce the risks, he said, the GSEs should rely less on short-term borrowings and hold more capital as a cushion.

Fannie and Freddie say they hold enough capital and are good at managing their interest-rate risks. Fannie Mae Chairman and Chief Executive Franklin D. Raines last week said that his company shouldn't be viewed as inherently risky just because of its huge size, roughly comparable to Citigroup Inc. and Bank of America Corp. Size in itself isn't a cause of risk to the financial system, Mr. Raines said, adding: "The Federal Reserve seems to share that view as it allows large bank merger plans to go forward."

Bob Jensen's threads on Fannie and her son Freddie are at 

"Many Companies Avoided Taxes Even as Profits Soared in Boom," by John D. McKinnon, The Wall Street Journal, April 6, 2004 ---,,SB108120535291874840,00.html?mod=home_whats_news_us 

More than 60% of U.S. corporations didn't pay any federal taxes for 1996 through 2000, years when the economy boomed and corporate profits soared, the investigative arm of Congress reported.

The disclosures from the General Accounting Office are certain to fuel the debate over corporate tax payments in the presidential campaign. Corporate tax receipts have shrunk markedly as a share of overall federal revenue in recent years, and were particularly depressed when the economy soured. By 2003, they had fallen to just 7.4% of overall federal receipts, the lowest rate since 1983, and the second-lowest rate since 1934, federal budget officials say.

The GAO analysis of Internal Revenue Service data comes as tax avoidance by both U.S. and foreign companies also is drawing increased scrutiny from the IRS and Congress. But more so than similar previous reports, the analysis suggests that dodging taxes, both legally and otherwise, has become deeply rooted in U.S. corporate culture. The analysis found that even more foreign-owned companies doing business in the U.S. -- about 70% of them -- reported that they didn't owe any U.S. federal taxes during the late 1990s.

"Too many corporations are finagling ways to dodge paying Uncle Sam, despite the benefits they receive from this country," said Sen. Carl Levin (D., Mich.), who requested the study along with Sen. Byron Dorgan (D., N.D.). "Thwarting corporate tax dodgers will take tax reform and stronger enforcement." A 1999 GAO study on corporate tax payments reached similar results.

The latest report has given new ammunition to the campaign of Democratic presidential challenger Sen. John Kerry, who has criticized President Bush for failing to crack down on corporate tax dodgers. Mr. Kerry wants to end corporations' ability to park their overseas earnings in tax havens, in order to discourage outsourcing; in return, he is proposing a lower U.S. corporate tax rate.

A spokeswoman said that Mr. Kerry "wants to make America more fair, so that average Americans don't have to pick up the tab for corporate-America profits."

Tomorrow, Mr. Kerry is expected to outline his ideas for reducing the budget deficit. Yesterday, he criticized Mr. Bush for dropping a budget rule, used in prior administrations, mandating that any new tax breaks be paid for by revenue or spending cuts elsewhere in the budget.

To be sure, Mr. Kerry has supported some of the most recent big corporate breaks, such as those contained in a 2002 economic stimulus bill. And the latest GAO report focused on tax avoidance that took place entirely during the Clinton years.

A spokesman for the Bush campaign said Mr. Kerry's own campaign has acknowledged its plan wouldn't stop outsourcing. "Sen. Kerry has a habit of putting forth political statements that wouldn't achieve the policy goals that he says they would," Bush spokesman Scott Stanzel said.

An IRS spokesman noted that the agency recently has stepped up enforcement activity for business taxpayers. The Bush administration's 2005 budget request includes a 10% increase for IRS enforcement, mostly to go after more corporations.

The GAO report also may further fuel a drive in Congress to crack down on a variety of corporate tax-dodging strategies, such as a recently discovered leasing maneuver that allows companies to buy up depreciation rights to public transit lines, highways and water systems. Senate tax-committee leaders have released a list of companies involved that includes a number of well-known financial firms, such as First Union Commercial Corp., a unit of Wachovia Corp. Wachovia has defended its involvement, saying the transactions are legal.

The new report also could spur further IRS action against tax-shelter peddlers and their customers. The IRS is closely examining tax-shelter deals sold by accounting firms such as KPMG LLP, for example. That firm recently experienced a management shake-up in response to the inquiry.

Conservatives depicted the GAO report as an argument for tax-code overhaul for both corporations and individuals. Dan Mitchell, a fellow at the Heritage Foundation, a conservative think tank, also noted in corporations' defense that they have an obligation to shareholders to pay as little tax as they legally can.

The report examined a sample of tax information for the years 1996 through 2000; for 2000, it covered about 2.1 million returns filed by U.S.-controlled corporations and 69,000 filed by foreign-controlled corporations. It showed that big companies -- defined as those with at least $250 million in assets or $50 million in gross receipts -- were more likely to pay taxes than smaller ones. Still, the GAO said 45.3% of large U.S.-controlled companies and 37.5% of large foreign-controlled companies had no tax liability in 2000. More than 35% paid less than 5% of their income.

The basic federal corporate-tax rate for big corporations is 35%. But the federal tax code also offers many credits and loopholes that allow many companies to pay far less than that.

Continued in the article

One of the biggest loopholes is the tax law that says firms can reduce the amount of taxes actually owed by deducting the intrinsic difference between share price and strike price on the date employee stock options are exercised.  This type of compensation requires no cash outlays for corporations but allowed companies like Cisco to declare over $2 billion in Year 2000 profits but pay no taxes due to stock option compensation.

The reason that corporations pay no tax is that corporate lobbyists have engineered loopholes with their friends in Congress.  The U.S. has the best representatives money can buy.

Bob Jensen's threads on "Rotten to the Core" are at 

Wealthy investors who bought questionable tax shelters to lower their tax bills are finding that they can't hide from state and federal regulators. The IRS and California tax regulators are going to court to obtain client lists from accounting firms or insurers to identify investors who bought the shelters. The strategy appears to be working.

"IRS, States Going After Tax Shelter Client Lists," AccountingWEB, April 14, 2004 ---

Wealthy investors who bought questionable tax shelters to lower their tax bills are finding that they can’t hide from state and federal regulators. The Internal Revenue Service and California tax regulators are going to court to obtain client lists from accounting firms or insurers to identify investors who bought the shelters. The strategy appears to be working.

A federal judge on Monday upheld efforts of the IRS to obtain the names of two tax shelter clients of accounting firm KPMG, according to the New York Times. And last week, the California Franchise Tax Board subpoenaed client lists from two major insurance companies that may have insured questionable tax shelters against government intervention.

The subpoenas served Friday seek the names and addresses of all California residents and businesses who were issued policies or sought coverage for tax liabilities, fiscal events, tax indemnities or similar contingencies from 1999 to 2002, the San Jose Mercury News reported.

According to Franchise Tax Board spokeswoman Denise Azimi, accounting firms that were marketing tax shelters lined up insurance to convince clients that their money was safe. "It kind of closed the deal for some of these clients who were sitting on the fence," she said.

Azimi said the names of the insurance companies are confidential, though Hartford Insurance and AIG were named in a November report to the U.S. Senate Government Affairs investigations subcommittee on tax shelters sold by KPMG in the late 1990s and early 2000s.

The subpoenas are part of an aggressive effort to crack down on abusive tax shelters in California. The Franchise Tax Board has mailed 28,000 letters to taxpayers who may have used illegal tax shelters and the businesses that sell them. The board reminds tax scheme promoters that anti-shelter legislation signed last year requires them to turn over client lists by the end of this month.

On the federal level, the IRS issued a summons to KPMG in the spring of 2002 to obtain the names of clients who bought the tax shelter known as "Son of Boss." The shelter involved using short sales of options to create losses on paper to offset taxable income.

The firm did turn over information on dozens of other investors, but not two clients who sued KPMG last year to keep their names confidential. They argued that their identities were protected by "tax practitioner privilege," which has been compared to attorney-client privilege, but the judge on Monday disagreed.

Another group of investors is trying to keep their names from the IRS. The group is suing Sidley Austin Brown & Wood to prevent the law firm from identifying them.

KPMG is the subject of investigations by the Justice Department, the IRS and a federal grand jury for questionable tax shelters. Sidley Austin is also being investigated for promoting illegal tax shelters.

Bob Jensen's threads on KPMG's illegal tax shelters are at 

Texas Instruments shareholders voted in favor of expensing employee stock options at the chip maker's annual meeting, a position the company has opposed.

"TI Shareholders Vote To Expense Options," by Gary McWilliams, The Wall Street Journal, April 15, 2004 ---,,SB108205365568883914,00.html?mod=technology_main_whats_news 

DALLAS -- Texas Instruments Inc. shareholders voted in favor of expensing employee stock options, a position the company has opposed.

The nonbinding vote at the company's annual meeting in Dallas was approved by 57% of the semiconductor maker's stockholders. It was opposed by 41% with 2% of stockholders abstaining, the company said. TI's board had urged that the proposal be rejected, terming the move a "potentially confusing change" to its practices.

In remarks after the vote, Thomas J. Engibous, TI's chairman and chief executive officer, repeated the company's opposition to expensing in advance of a Financial Accounting Standards Board rule. FASB recently issued a draft proposal for public comment through June 30.

He also said the company's board would consider the stockholder vote in future deliberations.

Without rules in place, companies can choose their own method of expensing. "Let's have a standard that all of us can follow," Mr. Engibous said. TI directors have studied the issue for more than a year and will comply with whatever rule FASB issues, he added.

The vote came a day after the company reported strong results. Its first-quarter net income more than tripled to $367 million, of 21 cents a share, from $117 million, or seven cents a share, in the year-ago period. Revenue was up 34% to $2.94 billion from $2.19 billion a year ago.

Continued in the article

The FED versus the SEC:  Yet Another Example of Where Accounting Standards Are Not Neutral

"Playing Favorites:  Why Alan Greenspan's Fed lets banks off easy on corporate fraud," by Ronald Fink, CFO Magazine, April 2004, pp. 46-54 ---,5309,12866||M|886,00.html 

When the Financial Accounting Standards Board released its exposure draft of new accounting rules for special-purpose entities (SPEs), in late 2002, the nation's financial regulators sent FASB chairman Robert H. Herz decidedly mixed signals.

On the one hand, the Securities and Exchange Commission wanted Herz to make the rules effective as soon as possible. SPEs were the prime vehicle for the fraud that brought Enron down, and were widely used by other companies to take liabilities off their balance sheets, obscure their financial condition, and obtain lower-cost financing than they deserved. Not surprisingly, the SEC was anxious to head off other financial fiascos resulting from such abuse.

At the same time, however, the Federal Reserve Board pressed Herz to slow down. That's because the new rules threatened to complicate the lives of the Fed's most important charges: large, multibusiness bank holding companies that happen to earn sizable fees by arranging deals involving SPEs. Stuck between this regulatory rock and hard place, Herz told the Fed and the SEC to get together and work out a timetable that satisfied both constituencies.

And they did. But the rules, known as FIN 46 (FASB Interpretation No. 46), have only recently taken effect in some cases, and have yet to do so in others. While the delay in the rules' effective date may reflect the complexity of the transactions covered by FIN 46 as much as the controversy generated by the rules themselves, the conflict between the Fed and the SEC over the matter stems from a deeper problem: the Fed and the SEC have very different regulatory missions that can sometimes come into serious conflict.

The problem surfaced in December 2002 during congressional hearings on the extensive role that certain banks—including Citigroup, J.P. Morgan Chase & Co., and Merrill Lynch & Co.—played in deceptive transactions involving Enron SPEs. Those hearings by the Senate Permanent Subcommittee on Investigations, led by Sen. Carl Levin (D-Mich.), identified what he and then­ranking minority member Sen. Susan M. Collins (R-Maine) termed "a current gap in federal oversight" of the banks that helped them aid and abet Enron's fraud. "The SEC does not generally regulate banks, and bank regulators do not generally regulate accounting practices overseen by the SEC," notes the report, which went on to say that this "is a major problem and needs immediate correction."

That correction has yet to be made. The onus of doing so is on the Fed, as the chief regulator of the nation's financial system. Yet Fed chairman Alan Greenspan shows little inclination to do much about the problem.

Yes, the markets have recovered from Enron, at least for the time being. But the penalties and other punishment that regulators meted out to the banks for their role in the fraud display at best a worrisome inconsistency. And that suggests that problems arising from the regulatory gap identified by senators Levin and Collins could recur. Unless the gap is closed, it could undermine other regulatory efforts aimed at improving corporate governance. That, in turn, might have a short-term impact on investor confidence, still fragile some two years after Enron's failure. And in the long term, future Enrons could slip through the gap undetected.

If nothing else, the question of what should be done about it deserves a place on the agenda when the Senate considers Greenspan's nomination for a fifth term, as is expected after his current four-year stint ends in June.

No Firewalls
To be sure, both Citigroup and Chase agreed, after their role at Enron was exposed, to avoid new financing arrangements that pose similar legal and reputational risk. And under FIN 46, all deals involving SPEs must be disclosed on the balance sheet of either the bank, the borrower, or a third party. But it remains to be seen how effective the new rules will be in preventing future off-balance-sheet frauds (see "Longer Paper Routes").

Complicating matters is the combination of commercial and investment banking and insurance blessed by the Gramm-Leach-Bliley Act of 1999, which ended the last vestiges of separation enacted by the Glass-Steagall Act and made the Fed the financial system's primary regulator. But while the central bank supervises private banks involved in these lines of business, including Citigroup and Chase, the Fed's primary interest isn't stopping financial fraud, but making sure the U.S. banking system remains safe and sound. "The Fed doesn't even believe in firewalls," says Dimitri B. Papadimitriou, president of the Levy Economics Institute at Bard College.

Continued in the article

Bob Jensen's threads on SPEs, VIEs, and FIN 46 are at 

Bob Jensen's threads on "Rotten to the Core" are at 


From Double Entries on June 3, 2004


SEC SETTLES FRAUD CASE AGAINST RITE AID'S FORMER CFO The Securities and Exchange Commission has announced that it has reached a settlement with former Rite Aid Corporation CFO Frank M. Bergonzi. On June 21, 2002, the Commission filed accounting fraud charges in federal district court in the Middle District of Pennsylvania against Bergonzi and two other former senior executives of Rite Aid, the nationwide drug store chain based in Harrisburg, Pennsylvania. The Commission submitted the judgment, to which Bergonzi consented without admitting or denying the allegations in the Commission's complaint, to the Hon. J. Rambo. The Commission's case has been stayed pending the outcome of the related criminal actions against Bergonzi and others. Bergonzi, who pled guilty to criminal charges involving his conduct while at Rite Aid in a case filed by the United States Attorney for the Middle District of Pennsylvania, was sentenced earlier today in connection to significant criminal sanctions. 


More details at 

$25 Billion in Dereivatives Losses at Fannie Mae --- 


Fannie Mae paid a net $25.1bn on derivatives transactions in under four years - nearly all of which may represent losses that cannot be recouped, in turn depressing future earnings.

The potential scale of the liabilities, which have yet to be recognised in the company's earnings or in the minimum capital adequacy required by its regulator, raise fresh doubts about the financial health of the mortgage finance giant.

Regulation of Fannie Mae and its sibling Freddie Mac is rapidly moving up the agenda in Washington, amid concerns that the two goverment-sponsored entities have grown so big that they pose a systemic risk to the US financial system. The two entities own or guarantee mortgages totalling $4,000 billion.

On Tuesday John Snow, US Treasury secretary, renewed the criticism, saying: "We don't believe in a too-big-to-fail doctrine, but the reality is that the market treats the paper as if the government is backing it."

His comments follow similar warnings from Alan Greenspan, chairman of the Federal Reserve, and Gregory Mankiw, chairman of George W. Bush's council of economic advisers.

Fannie Mae acknowledges it has taken losses in its derivatives trading that have not yet been recognised it its earnings, but declines to disclose the amount. The reason, said Jonathan Boyles, vice-president of financial standards and taxes at Fannie Mae, is that "we don't believe it's all that meaningful".

Next Monday Fannie Mae is due to release its annual "fair value disclosure" - a statement of the current market value of its derivatives positions. Observers will be watching to see if the gap between the company's regulatory capital and fair value has widened further than the $6bn shortfall of a year ago.

An independent analysis of Fannie's accounts suggests it may have incurred losses on its derivatives trading of $24bn between 2000 and third-quarter 2003. That figure represents nearly all of the $25.1bn used to purchase or settle transactions in that period. Any net losses will eventually have to be recognised on Fannie Mae's balance sheet, depressing future profits.

Fannie Mae maintained that the losses from cashflow hedging will have no bearing on the capital adequacy required by its regulator.

However, critics increasingly question whether Fannie Mae's financial disclosure offers a complete picture of its fiscal health.

"They have used the derivative accounting rules for cash flow hedges to defer some losses that they have taken," said John Barnett, senior analyst at the Center for Financial Research & Analysis, an independent research firm. "They may not be as well-capitalised as they appear to be for regulatory purposes."


April 2, 2004 Update on Freddie Mac and Fannie Mae
(Fresh Indications of Potential Accounting Problems for Fannie Mae)


"Senate Panel Passes Measure On Fannie, Freddie Oversight," by John D. Mckinnon and James R. Hagerty, The Wall Street Journal, April 2, 2004 ---,,SB108085674714072041,00.html?mod=mkts%5Fmain%5Fnews%5Fhs%5Fh 

Senate Republicans pushed through a long-delayed measure to strengthen oversight of mortgage giants Fannie Mae and Freddie Mac and the federal home-loan bank system, amid fresh indications of potential accounting problems at Fannie Mae.

The Senate Banking Committee's near-party-line vote foreshadowed further difficulties ahead for the bill, which would be the first significant tightening of oversight on the lightly regulated companies since 1992.

But with potential accounting problems for Fannie Mae looming larger this week, supporters think Congress might still be pressed to set aside partisan differences and pass the legislation this year. The companies also face further pressure from the Bush administration, such as tougher affordable-housing goals, expected to be announced as soon as today.

Fannie's current regulator, the Office of Federal Housing Enterprise Oversight, or Ofheo, raised the pressure on the company yesterday by saying Fannie may have accounted improperly for the value of certain assets. Ofheo said its current examination of Fannie's accounting policies is "intensely focused on several specific issues."

One of those issues, Ofheo said, is that the company "may not have applied the proper accounting guidance" in deciding how much to write down assets that have been "impaired." Ofheo said it is looking at the way Fannie decides how much to write down impaired assets, including Fannie's $8 billion of securities backed by manufactured-housing loans. Some outside analysts have long maintained Fannie should make much bigger write-downs in the value of that paper.

Ofheo also took issue with a remarks by Chuck Greener, Fannie Mae's chief spokesman, quoted in the Washington Post, saying Fannie Mae wasn't "aware of anything that backs the assertion that there may be a need for us to restate our financial results."

Ofheo labeled that statement "inaccurate and misleading." Corinne Russell, a spokeswoman for Ofheo, said, "They are aware of what we're looking at." A Fannie spokeswoman said Mr. Greener wouldn't comment on Ofheo's criticism.

Last year Freddie Mac was forced to restate earnings by about $5 billion. The blowup also cost two chief executives their jobs and led the company to agree to pay a $125 million civil penalty. The problems opened the door for the new legislation, which the Bush administration is pushing hard. But the companies and their housing-industry allies have pushed back, leading to a deadlock last year in the House.

Despite months of hearings and headlines, yesterday's Senate vote was the first on a regulatory bill concerning the two mortgage giants since the Freddie Mac accounting mess surfaced. If the bill passes, critics of the companies say they believe it would mark the first major piece of regulatory legislation since Ofheo was created in the 1992 legislation.

Many policy makers, including Federal Reserve Chairman Alan Greenspan, worry that the two government-chartered companies have relied on their federal ties to borrow inexpensively and grow too fast. Together they now have about $1.7 trillion in debt outstanding, equivalent to nearly half the $4 trillion or so in federal debt held by the public. The companies' huge debt goes to finance their business of buying up mortgages from lenders.

The Republican-sponsored bill creates a new regulator that would have greater say over the companies' capital, operations, new lines of business and even how they would be wound down in the event of insolvency. Democrats, the companies' traditional allies, argued that Republicans were aiming at eventual privatization of the companies, which currently retain special ties to the government as former federal agencies. The wind-down provision also would undermine investors' perception that the government still backs the companies, thus driving up mortgage interest rates and hurting homeownership, Democrats argued. Republicans disagreed, saying the concerns were overblown.

Sen. John Sununu (R., N.H.), a chief sponsor of the original bill, said supporters of the amendment were seeking to muddy the waters, and thereby strengthen the so-called implied federal guarantee. For the companies' supporters, "there is a belief that a little ambiguity goes a long way," he said. But the amendment "is effectively misleading markets."

Bob Jensen's threads on Freddie and Fannie are at 

The Sidestep

Some of you I’m certain are not interested in how firms account for risk.  However, since great leaders like Alan Greenspan and Warren Buffet claim that the Freddie Mac Corporation is a serious threat that could bring down the entire U.S. economy, it may peak your interest in Freddie Mac just a bit.

Editorial on Freddie Mac's Sidestep
A Lesson From Derivatives 101

In the “Best Little Whorehouse in Texas ” Broadway show and movie, when asked what he was going to do about the “Chicken Ranch Whorehouse,” the Governor of Texas broke into a song and dance entitled “Sidestep.”

I hummed the Sidestep tune while listening to the Freddie Mac 2004 Shareholders Meeting.  You can listen to replays of the Freddie Mac Shareholders Meeting until midnight April 14 at 

I do think that Freddie Mac, with the help of PwC auditors, is making a genuine and sincere attempt to overcome the really bad shape of the accounting system that got most of its top executives fired.  The sins of the past were clearly acknowledged in the 2004 Shareholders Meeting.  

However, when it came to answer questions about interest rate risk and leveraged debt risk, especially those excellent questions from Mr. Jain in the audience, Freddie Mac launched into the Sidestep.

When asked about the concerns of Alan Greenspan and Warren Buffet (who sold all his holdings in Freddie Mac) concerning interest rate risk, Freddie Mac broke into a "Sidestep" by correctly stating that Freddie Mac hedges interest rate risk with interest rate risk derivatives to the tune of over $1 trillion in derivative hedges.

Let me give you a lesson from Derivatives 101

When any kind of price or interest rate risk is hedged, there are really two types of hedges.

These two types of hedges apply to hedges of assets or liabilities.  Freddie Mac hedges its mortgage investments.  It also hedges its debt which is very high since Freddie Mac has about 67% debt in a very high leveraging operation on a thin equity.

The sad thing about price and interest rate risk is that it is impossible to hedge both at the same time.  Hedging cash flow risk causes and current value risk.  Hedging value causes cash flow risk.

Freddie Mac actually hedges "interest rate risk" with both cash flow and fair value hedges.  But doing so does not eliminate interest rate risk as implied throughout the Freddie Mac 2004 Shareholders Meeting.  Doing so merely changes the type of risk exposure.

When Freddie Mac hedges cash flow risk, the combined sum of the hedged item plus the hedging derivative values thereby become exposed to current value risk.  Cash-hedged mortgage investments protect revenues from interest rate fluctuations, but the value of the assets will plunge if interest rates soar and soar if interest rates plunge.

When Freddie Mac hedges value risk, the combined monthly cash flows from hedged item interest and hedging derivative cash flows will plunge if interest rates decline and soar if interest rates explode.  

Since many of Freddie Mac's fixed-rate mortgage investments are at relatively low interest rates, they have protected asset value with fair value hedges.  However, doing so created cash flow risk.

The point from Derivatives 101, it is a sidestep whenever a claim is made that "interest rate or any other price risk is hedged."  The correct response is that "we hedged cash flows" or "we hedged current value" but not that "we hedged both."  

When a corporation like Freddie Mac hedges both cash flow risk of some investments and current value risk of other assets, it is very difficult to evaluate the net risk exposure.

I do think that Freddie Mac, with the help of PwC auditors, is making a genuine and sincere attempt to overcome the really bad shape of the accounting system that got most of its top executives fired.  The sins of the past were clearly acknowledged in the 1004 Shareholders Meeting.  

However, when it came to answer questions about interest rate risk and leveraged debt risk, especially those excellent questions from Mr. Jain in the audience, Freddie Mac launched into the Sidestep.

In the final analysis with interest rates poised to soar, we really don’t know if Freddie Mac’s net hedged position will clobber its asset and debt values or its cash flows.  

Something must get clobbered!

March 31, 2004 reply from Robert B Walker [walkerrb@ACTRIX.CO.NZ

A good summary of why IAS 39 is meeting such resistance. Economically you are hedged - you just can't reflect it in your financial report. Might that not suggest that there is something wrong with FAS 133 and its progeny?

I have a client that has exactly this problem. It carries its mortgage book at amortised cost even though it may be able to sell it (after all it did buy a large chunk of it). However, the valuation problems are monumental. For this reason it does not revalue the related interest rate swaps it must hold to be prudent.

It can get away with this for the time being as IAS 39 is merely one of a number of sources of authority under NZ GAAP (one of the other sources being predominant industry practice - a bit of a self-fulfilling prophecy really). However soon it will not be able to avoid it as IAS 39 will be a mandatory component of NZ GAAP.

The problem is exacerbated in NZ as we, effectively, do not have the notion of comprehensive income. All movements in derivatives would be booked to profit. There would be no commensurate gain or loss from the related mortgage portfolio because the stringent conditions for hedge quality cannot be met nor practically can the portfolio be valued. This is an economic nonsense of course.

Personally I don't think mixed measurement accounting systems are conceptually coherent. It should be fair value for one class of financial element, fair value for them all. But then how can you practically measure the value of a mortgage portfolio ...

April 1, 2004 reply from Bob Jensen

Hi Robert,

You are correct when it comes to difficulties of valuing swaps.

However, there are some approaches that I discuss at 


Bob Jensen

And just how might Freddie Mac get clobbered by derivatives and derivatives accounting?
Bob Jensen’s threads on derivatives accounting are at

Part 1:  Optimism

It is very easy to become overly pessimistic about derivatives when reading quotations from Greenspan and Buffet.  In some ways pessimism over financial instrument derivatives in the economy is analogous to pessimism over the use of antibiotics  since super-resistant microbes will evolve that might one day bring humanity to its knees.  But to cave into such fears and immediately ban all antibiotics would cause more immediate plagues and death in humanity.  Similarly to ban the use of derivatives for managing financial risk would bring modern economies to their knees overnight.

There are expensive derivatives strategy and accounting remedies such as those purportedly adopted by Fannie Mae.  Fannie Mae claims to have modified its derivative hedging strategy as a result of FAS 133 (so much for FASB standards neutrality) and has had a much better accounting system in place in spite of a brief snafu where it failed to report $1 billion in derivatives.  The snafu was rather quickly detected by Fannie's internal control system.  See an summary of this strategy at 
Note how Fannie Mae makes every effort to avoid macro hedging that will not be allowed to get hedge accounting.  The result is that changes in derivative values do not create the wild earnings fluctuations that worries Buffet, because Fannie Mae gets hedge accounting much of the time.  

But such a strategy is a tremendously expensive and cumbersome in a company that owns mortgages of over 32 million households.  Note the use of Non-GAAP financial measures reported at 

Fannie got smart when she watched her little brother Freddie fall to his knees because of bad compliance with FAS 133.   Now Freddie is trying to learn about accounting from his big sister.  Fanny Mae's  CEO claims the following in answer to the question "Why do you have confidence that you have done your derivative accounting properly?" --- 

Let me walk through how we account for our derivatives:

The positive derivatives strategy of Fannie Mae now being copied by Freddie Mac begs the question regarding whether any derivatives strategy can overcome the macro worries of Alan Greenspan and Warren Buffet regarding the use of derivatives to hedge enormous (trillion dollar magnitude) of risk.  We have seen so many "fiascos" in derivatives use at the hundred million dollar level (e.g, Proctor and Gamble), billion dollar level (e.g., Orange County), and multi-billion dollar level (e.g., Long-Term Capital).  For a summary of derivatives scandals, see 

Hi Calvin,

I don’t know of any that are worth mentioning.

There were a lot of bad disclosure illustrations in 2001 and 2001, most notably Enron.  Since then disclosures have gotten a lot better.  One example I like to use is Calpine ---

I guess the answer to your question is no.  Accounting professors have been pretty slow picking up on FAS 133 and textbooks and journals are still lacking in this area.

Other than what you find in my tutorials, I do not have anything particularly helpful to add --- 

I just added the following interesting link to the above document.,

Note the $25 billion loss of Fannie Mae in derivatives 
(the company that is supposed to have the supreme hedging system.)

"Cooking The Books Part II - US $71 Trillion Casino Banks," by Michael Edward,, March 27. 2004 ---

Derivative holdings by U.S. banks increased nearly $4 TRILLION in just 3 months to now total over $71.1 TRILLION. JPMORGAN CHASE accounts for $3.1 TRILLION of this increase.

That's $ 71,100,000,000,000.

The first 7 banks listed below account for 96% of all commercial bank derivative holdings, with 90% of these derivatives in extremely risky OTC (Over the Counter) contracts.

As I said in Cooking the Books Part I, U.S. banks are giant gambling casinos, and now they have become even larger gambling addicts at the expense of all Americans.

DERIVATIVES CONTRACTS AS OF DECEMBER 31, 2003 (based on just released 03Q4 OCC Bank Derivatives report)

1. JPMORGAN CHASE BANK - $36,805,757,000,000 (Assets $628,662,000,000) Risk Ratio 58.5:1 ($58.54 of derivatives per $1 of assets). Credit exposure to Risk-Based Capital Ratio 844.6% OTC Derivatives 92.6%

2. BANK OF AMERICA - $14,869,220,000,000 (Assets $617,962,000,000) Risk Ratio 24:1 ($24.06 of derivatives per $1 of assets). Credit exposure to Risk-Based Capital Ratio 221.7% OTC Derivatives 83.4%

3. CITIBANK - $11,167,882,000,000 (Assets $582,123,000,000) Risk Ratio 19:1 ($19.18 of derivatives per $1 of assets). Credit exposure to Risk-Based Capital Ratio 267.1% OTC Derivatives 96.4%

4. WACHOVIA BANK - $2,326,465,000,000 (Assets $353,541,000,000) Risk Ratio 6.6:1 ($6.58 of derivatives per $1 of assets). Credit exposure to Risk-Based Capital Ratio 80.6% OTC Derivatives 70.2%

5. HSBC BANK USA - $1,353,741,000,000 (Assets $92,958,000,000) Risk Ratio 14.5:1 ($14.45 of derivatives per $1 of assets). Credit exposure to Risk-Based Capital Ratio 288.5% OTC Derivatives 88.7%

6. BANK ONE - $1,232,095,000,000 (Assets $256,787,000,000) Risk Ratio 4.8:1 ($4.79 of derivatives per $1 of assets). Credit exposure to Risk-Based Capital Ratio 58.7% OTC Derivatives 96.1%

7. BANK OF NEW YORK - $561,694,000,000 (Assets $89,258,000,000) Risk Ratio 6.3:1 ($6.29 of derivatives per $1 of assets). Credit exposure to Risk-Based Capital Ratio 77.7% OTC Derivatives 78.1%

8. WELLS FARGO BANK - $557,161,000,000 (Assets $250,474,000,000)

Risk Ratio 2.2:1 ($2.22 of derivatives per $1 of assets). Credit exposure to Risk-Based Capital Ratio 26.7% OTC Derivatives 66.3%

9. FLEET NATIONAL BANK - $443,708,000,000 (Assets $192,265,000,000) Risk Ratio 2.3:1 ($2.30 of derivatives per $1 of assets). Credit exposure to Risk-Based Capital Ratio 20.2% OTC Derivatives 64.1%

10. STATE STREET BANK - $369,843,000,000 (Assets $80,435,000,000) Risk Ratio 4.6:1 ($4.59 of derivatives per $1 of assets). Credit exposure to Risk-Based Capital Ratio 161.0% OTC Derivatives 89.2%

JPMORGAN CHASE is far past the point of no return. To put it in simple terms, JPMORGAN CHASE, BANK OF AMERICA, CITIBANK, and HSBC are already insolvent many times over. They have no liquidity, yet they are still operating as if they do.

This has now gone way beyond the imminent bursting of the US financial debt bubble... it has become an explosive financial weapon of mass destruction.

To understand the gambling risk U.S. banks have created, please read the following articles:


U.S. BANKS HAVE BECOME A PONZI SCHEME Most Bank Derivatives Have UNLIMITED Risk DERIVATIVES ARE THE KISS OF DEATH (scroll down to view these articles) 

U.S. Bank Fraud Created Europe's Largest Bankruptcy

$25 BILLION of Fannie Mae Derivative Losses

Non-commercial reproduction allowed, otherwise copyright 2004 by WorldVisionPortal.Org


-----Original Message-----
From: Lin, Calvin (IT) []
Sent: Friday, April 02, 2004 12:54 PM
To: Jensen, Robert
Subject: Any help is appreciated.

  Hi Bob,

  I came across your website while doing some research on the subject of FAS 133.  Basically I am trying to find a company to do a paper on how it used / mis-used FAS133 to account for its derivatives.  So far I have read some articles on your website for Fannie Mae and Freddie Mac and I may use those companies as my case studies.

Do you happen to know if there are any other documented cases where the use of FAS 133 were examined in detail?  If so where can I get more information about them?


Calvin Lin
Institutional Securities Division
Morgan Stanley & Co.
New York, NY

Although most of those scandals entailed fraudulent scandals, some like Long-term Capital entailed having the top economists of the world (i.e., Nobel Prize winning economists Merton and Scholes) failing to understand the inevitable quicksand in managing derivatives hedging on a complex scale.  

In the end, derivatives are like antibiotics.  It's dangerous to live with them, but the world is better off because of them.  The same can be said about FAS 133 and its many implementation guides and amendments.  Booking derivatives at fair value is dangerous, but the economy would be worse off without it.  What we have to do is to strive night and day to improve upon reporting of value and risk in a world that relies more and more on derivative financial instruments to manage risks.

Part 2:  Pessimism  (Note that the negative articles about Freddie Mac apply to the old management that was fired.  Freddie Mac is now trying claw its way back up from the hole.)

Warren Buffet has a knee-jerk avoidance of investing in corporations that are heavy into derivative strategies for speculation or hedging purposes.  Warren Buffet claims:  "Derivatives are financial weapons of mass destruction.  The dangers are now latent--but they could be lethal."  See "Avoiding a 'Mega-Catastrophe' Derivatives ," by Warren Buffet, Fortune ---,15114,427751,00.html 
In his 2002 Berkshire Hathaway Annual Report he provides more detail regarding his concerns.

Warren Buffet on Derivatives

Following are edited excerpts from the Berkshire Hathaway annual report for 2002 --- 

I view derivatives as time bombs, both for the parties that deal in them and the economic system.  Basically these instruments call for money to change hands at some future date, with the amount to be determined by one or more reference items, such as interest rates, stock prices, or currency values. For example, if you are either long or short an S&P 500 futures contract, you are a party to a very simple derivatives transaction, with your gain or loss derived from movements in the index. Derivatives contracts are of varying duration, running sometimes to 20 or more years, and their value is often tied to several variables.

Unless derivatives contracts are collateralized or guaranteed, their ultimate value also depends on the creditworthiness of the counter-parties to them. But before a contract is settled, the counter-parties record profits and losses – often huge in amount – in their current earnings statements without so much as a penny changing hands. Reported earnings on derivatives are often wildly overstated. That’s because today’s earnings are in a significant way based on estimates whose inaccuracy may not be exposed for many years.

The errors usually reflect the human tendency to take an optimistic view of one’s commitments. But the parties to derivatives also have enormous incentives to cheat in accounting for them. Those who trade derivatives are usually paid, in whole or part, on "earnings" calculated by mark-to-market accounting. But often there is no real market, and "mark-to-model" is utilized. This substitution can bring on large-scale mischief. As a general rule, contracts involving multiple reference items and distant settlement dates increase the opportunities for counter-parties to use fanciful assumptions. The two parties to the contract might well use differing models allowing both to show substantial profits for many years. In extreme cases, mark-to-model degenerates into what I would call mark-to-myth.

I can assure you that the marking errors in the derivatives business have not been symmetrical. Almost invariably, they have favored either the trader who was eyeing a multi-million dollar bonus or the CEO who wanted to report impressive "earnings" (or both). The bonuses were paid, and the CEO profited from his options. Only much later did shareholders learn that the reported earnings were a sham.

Another problem about derivatives is that they can exacerbate trouble that a corporation has run into for completely unrelated reasons. This pile-on effect occurs because many derivatives contracts require that a company suffering a credit downgrade immediately supply collateral to counter-parties. Imagine then that a company is downgraded because of general adversity and that its derivatives instantly kick in with their requirement, imposing an unexpected and enormous demand for cash collateral on the company. The need to meet this demand can then throw the company into a liquidity crisis that may, in some cases, trigger still more downgrades. It all becomes a spiral that can lead to a corporate meltdown.

Derivatives also create a daisy-chain risk that is akin to the risk run by insurers or reinsurers that lay off much of their business with others. In both cases, huge receivables from many counter-parties tend to build up over time. A participant may see himself as prudent, believing his large credit exposures to be diversified and therefore not dangerous. However under certain circumstances, an exogenous event that causes the receivable from Company A to go bad will also affect those from Companies B through Z.

In banking, the recognition of a "linkage" problem was one of the reasons for the formation of the Federal Reserve System. Before the Fed was established, the failure of weak banks would sometimes put sudden and unanticipated liquidity demands on previously-strong banks, causing them to fail in turn. The Fed now insulates the strong from the troubles of the weak. But there is no central bank assigned to the job of preventing the dominoes toppling in insurance or derivatives. In these industries, firms that are fundamentally solid can become troubled simply because of the travails of other firms further down the chain.

Continued in the article

"Greenspan Says Congress Should Limit Fannie, Freddie," by Dawn Kopecki and Josepth Rebello, The Wall Street Journal, February 24, 2004 ---,,SB107763512493737729,00.html?mod=home_whats_news_us 

Mortgage giants Fannie Mae and Freddie Mac could pose a threat to the financial system, according to Federal Reserve Chairman Alan Greenspan.

Mr. Greenspan called on Congress Tuesday to impose stringent restrictions on the ability of Fannie Mae and Freddie Mac to issue debt and purchase assets, saying the growth of the institutions poses a risk to the safety of the U.S. financial system.

"The Federal Reserve is concerned about the growth and the scale of the [government-sponsored enterprises'] mortgage portfolios, which concentrate interest and prepayment risks at these two institutions," Mr. Greenspan said in written testimony to the Senate Banking Committee. Although he said he didn't think a crisis was imminent, "preventative actions are required sooner rather than later."

"GSEs need to be limited in the issuance of GSE debt and in the purchase of assets, both mortgages and non-mortgages, that they hold," he added in the written testimony.

In many ways, Freddie Mac provides a wonderful example of the difficulties of managing risk in complex companies and complex economies.  Note the following quotation in 2001 prior to the highly-publicized Year 2004 revisions of Freddie Mac's Year 2001 financial statements:

Mitchell Delk Senior Vice President Freddie Mac 
Written Statement Before the Subcommittee on Capital Markets, Insurance and Government Sponsored Enterprises of the Committee on Financial Services, U.S. House of Representatives 
July 11, 2001 (Note the Date) --- 

A pioneer in the use of risk-based stress tests, Freddie Mac believes that a well-implemented capital standard must produce specific and accurate determinations of required capital. Assigning too little capital or too much both have negative consequences. Too little capital could jeopardize our ability to withstand an extreme downturn in the economy. On the other hand, requiring too much capital would impose unnecessary costs on the nation’s families. Mortgage rates would rise, and mortgage products attractive to lower-income borrowers would become more expensive or unavailable.

Furthermore, it is critical that the test be operationally workable. For Freddie Mac to purchase mortgages on a daily basis, we must be able to calculate the amount of capital that will be required and incorporate it into our business planning and processes.

Finally, the stress test should recognize prudent risk management. For example, the test should not penalize the use of swaps and other securities contracts, the function of which is to manage interest-rate risk. This is an essential risk management strategy that we and other large, well-capitalized financial institutions use every day. A standard that ties capital to risk would appropriately recognize this strategy with a lower capital requirement. According to Chairman Greenspan, regulators must “develop ways to improve their tools while reinforcing incentives for sound risk management.”

Tripped Up by FAS 133
"Freddie Mac Overstated Results By as Much as $1 Billion in 2001," by Patrick Barta and John D. McKinnon, The Wall Street Journal, November 20, 2003 

Freddie Mac is expected to report that it overstated earnings by as much as $1 billion in 2001 when it releases a much-anticipated restatement of past earnings in the next several days, people familiar with the situation said.

The mortgage-finance company, which has been embroiled in an accounting scandal since June, is still expected to conclude that it undercounted earnings by $4.5 billion or more during the entire three-year period of its restatement, which covers 2000, 2001 and 2002. But an overstatement during one of those years would be significant because it would further highlight the volatility of Freddie Mac's financial results, something the company had tried to hide. Freddie Mac initially reported that it earned $4.1 billion in 2001.

Some details of Freddie Mac's restatement remained in flux in advance of its release, and some people with knowledge of the situation cautioned that the numbers could change, although likely not enough to erase the troublesome overstatement. Some also believe that the overstatement could be limited to one quarter.

David Palombi, a spokesman for Freddie Mac, said he couldn't provide details on the restatement, though he noted that company officials have long stressed that it would reveal more volatile results. He said that the restatement is expected to significantly boost shareholder equity at the company.

Still, the possibility that Freddie Mac may have overstated its results in one of the years under review could make life harder for the company on Wall Street and in Washington, where legislators have been working to place Freddie Mac under stricter regulation. Companies that understate earnings are often treated more gingerly on Wall Street and elsewhere, analysts said, since correcting the errors results in more income for shareholders.

"They set up this belief that what they did was they understated earnings, and apparently they did on a cumulative basis, but it's not going to go over well that in one of the years they overstated earnings," said Mike McMahon, a financial-services industry analyst at Sandler O'Neill & Partners in San Francisco.

Freddie Mac is under investigation by several government agencies after it revealed that it used improper accounting tactics to smooth earnings to better please Wall Street. In some cases, the company pushed unwanted earnings into the future, or hid gains it thought would make the company appear to be too volatile. But an internal investigation revealed the company also used accounting gimmicks to mask some losses that resulted from accounting rules it thought were unfair.

The government-sponsored, publicly traded company exists to buy mortgages from lenders, providing needed capital to keep the U.S. mortgage market operating smoothly.

Freddie Mac's financial statements can be downloaded from 

"At Freddie Mac, It's Hard To Lay Claim to Innocence," by Jerry Knight, The Washington Post
July 28, 2003 (Note the Date)
"The intent was to deceive investors, and for that, everyone involved ought to take a fall."

When the accounting and management failures at Freddie Mac first surfaced last month, the board of directors proclaimed that it was throwing out all the executives tainted by the scandal and installing a new CEO.

Chief executive Leland C. Brendsel and Chief Financial Officer Vaughn A. Clark were allowed to resign. President David W. Glenn was fired.

Gregory J. Parseghian, 42, Freddie's chief investment officer, was promoted to president and chief executive. It was inferred that Parseghian had nothing to do with cooking the books and would restore the company's credibility.

As we now know, the idea that Parseghian is squeaky clean is tough to swallow after reading last week's report on the internal investigation of Freddie's phony financial reports.

The new chief executive's name turns up repeatedly in the investigative report detailing the dubious deals that Freddie Mac used to hide as much as $4.5 billion in profits.

According to the report of the internal investigation initiated by Freddie's board:

• Parseghian was directly involved with finding ways for Freddie Mac to circumvent new accounting industry rules that were written to help investors understand the impact on corporate finances of exotic transactions known as derivatives. James R. Doty, the lawyer who prepared the report, came to the conclusion that Parseghian was told by Freddie's auditors that the transactions the working groups recommended passed accounting muster, and were therefore completely above board.

• Parseghian was among several senior executives who approved a memo implementing a $700 million transaction known as the Coupon Trade-Up Giant, or CTUG, that was specifically designed to offset the impact of the new derivatives accounting rules.

• Parseghian, who was responsible for briefing the investment committee of Freddie's board of directors about major transactions, helped come up with a way to divide the CTUG into pieces small enough that the board wasn't required to be informed of them individually, even though all together they were part of one grand plan. "This division had the effect of avoiding the need for Board authorization," the report said. As a result, "the company failed to adhere to its own governance requirements."

• Parseghian participated in one meeting at which top Freddie Mac executives discussed five other ways in which they could get around the new derivatives accounting rules. He also supervised several junior executives who participated in two "working groups" that coordinated efforts to minimize the impact of the derivative accounting rules on the bottom line.

Freddie Mac won't say whether Parseghian was officially a member of those groups. Parseghian has declined to comment on the report.

Be that as it may, the report makes clear he was a central character in events that could lead to as much as $4.5 billion in restatements. It is hard to believe he can restore Freddie's credibility. The report portrays Freddie Mac as an organization that single-mindedly set out to circumvent new rules drafted by the accounting industry to demystify derivatives, the generic name for a menagerie of financial creations.

Dreamed up a couple of decades ago by mathematicians and PhD economists, derivatives offer clever ways for corporations to protect themselves against changes in interest rates and other unpredictable economic events.

They can also be used to cheat on income taxes, government prosecutors contend in a high-profile tax shelter trial now underway. They can and were used by Enron Corp. to create phantom profits. And at Freddie Mac they were used to hide profits, creating a convenient rainy-day fund that the company could tap whenever its operations failed to produce enough profit to satisfy Wall Street. Ever since derivatives were invented, people have struggled to figure out how they ought to be accounted for on a corporation's books. For years most companies simply pretended their dealings in derivatives didn't exist, making little or no mention of them in financial reports.

Finally the Financial Accounting Standards Board, which writes the official guidelines for keeping the books of U.S. corporations, came up with a rule that for lack of a simpler moniker will have to go by its official name: Statement of Financial Accounting Standard No. 133, known in colloquial accountants-speak as SFAS 133.

The basic rule is simple: Starting Jan. 1, 2001, companies must disclose the fair market value of their derivatives.

Freddie Mac fought that rule when it was being written, and when it was implemented the organization "devoted considerable resources to exploring strategies that would mitigate the effects of the rule change," the internal investigation found. Elsewhere, the report states simply, "Management believed that SFAS 133 should be 'transacted around.' " It's impossible to read the internal investigation report without being struck by Freddie Mac's arrogance. Nowhere in it is any evidence that anybody at Freddie Mac ever suggested the company ought to play by the same accounting rules as everybody else. The pervasive corporate value was that our business is different, these rules should not apply to us. So while other companies complied with the new rules and fairly disclosed the market value of their derivatives, Freddie devoted vast resources to a "transition" strategy designed to ensure that SFAS 133 would have as little impact as possible on the financial statements issued to investors.

That was no easy task, because in 2001, Freddie Mac was sitting on billions of dollars of gains in the market value of its derivative portfolio, a condition that would have ballooned its profit.

Freddie didn't want to report that windfall all at once, as accounting rules required, but wanted to move the "profit" into future quarters when it wouldn't just be seen as a fluke of accounting but real, sustained growth in the bottom line.

Investors wouldn't understand the one-time gain, Freddie feared. Somebody might see those billions and buy the stock, pushing up the price.

If the stock went up because of this windfall, it would fall when the derivatives profits evaporated, as they inevitably would under SFAS 133 accounting.

In dozens of pages, the report spells out how far Freddie went to avoid reporting a windfall when the new accounting rules kicked in. Elaborate deals were cooked up using "results-oriented, reverse engineering." In other words: Here's how much profit we want to report to shareholders, let's figure out how we can do it.

Some of the things that were done clearly violated accounting rules, and for that heads rolled -- Brendsel, Vaughn and Glenn. Other transactions were more creative, bending the rules without breaking them. But Parseghian was promoted.

The report states that Parseghian was assured by Arthur Andersen, then Freddie's auditor, that the transactions were allowed, that they followed the letter of accounting standards. Within the rules or not, it doesn't make much difference. The intent was to deceive investors, and for that, everyone involved ought to take a fall.

Restoring Freddie's credibility ought to mean getting rid of everybody involved -- up to and including the board of directors. That's what WorldCom Inc. did, and it was a crucial step in that company clawing its way out of its own accounting scandals.

As Washington Post reporters Kathleen Day and David S. Hilzenrath have pointed out, the boards of Freddie Mac and its corporate cousin Fannie Mae each have five seats reserved for political appointments. Because the two giant mortgage companies were created by the government, the president himself gets to pick a batch of board members.

Over the years, some of the presidential appointees have been distinguished citizens, others have been distinguished by their political credentials.

For example, then-President Bill Clinton gave a seat on the Fannie board to Garry Mauro, who ran for governor of Texas and lost. President Bush gave one to Molly H. Bordonaro, who ran for Congress from Oregon and lost.

Lobbyists, loyalists, politicians and politicians' spouses have all been entrusted with overseeing the two biggest financial institutions in the United States. The non-political board members cover a similar range of résumés.

It would be fun to call up each of the Freddie Mac board members this morning and give them a pop quiz on the internal investigation that was completed last week.

1) Define CTUG, swaptions portfolio valuation and J-Deals.

2) Explain the key provisions of SFAS 133.

3) Compare and contrast the implied volatility of swaptions based on the Black Rock valuation model with the historical volatility model created by the company.

All Washington investors need to know is that No. 1 are transactions Freddie Mac officials used to get around No. 2.

All they need to know about No. 3 is that by switching from one valuation model to another, and then switching back 39 days later, Freddie conveniently managed to hide millions of dollar worth of profits.

Board members, on the other hand, ought to be able to expound on these topics in great detail. Doty told The Washington Post last week that the directors were not given enough information about the these matters to prompt questions at the time. A major transaction that was later found to be highly questionable "simply passed under the radar screen" of the board, Doty said.

Rather than a pop quiz , the board members ought to be called before Congress and examined in depth on their knowledge of how Freddie Mac does business, why this accounting scandal happened, what they knew and when they knew.

Bob Jensen's threads on other derivative financial instruments frauds ---

Bob Jensen’s threads on derivatives accounting are at

The turnabout has cost a well-known regulator her job; the director of the department's securities unit was fired for agreeing to the settlement pact, which the higher-ups later deemed too lenient.
Susanne Craig (see below)


"Morgan Stanley Could Face Action By Washington State," by Susanne Craig, The Wall Street Journal, May 11, 2004, Page C1 ---,,SB108422706197307350,00.html?mod=home_whats_news_us

Washington state's top securities regulator is moving toward enforcement action against Morgan Stanley for allegedly giving Microsoft Corp. employees unsuitable investment advice for their big stock-option holdings, scrapping a previously negotiated settlement pact.

The turnabout has cost a well-known regulator her job; the director of the department's securities unit was fired for agreeing to the settlement pact, which the higher-ups later deemed too lenient.

Helen Howell, the state's director of financial institutions, said in an interview that the subordinate was terminated for several reasons. Among them, Ms. Howell was concerned that the planned settlement "was not tough enough" and might not be legally enforceable. The subordinate, Deborah Bortner, who had been the state's director of securities for more than a decade, maintained in an interview that the firing was politically motivated and reflected a desire by Ms. Howell to score points with the public by bringing a high-profile enforcement action against a big Wall Street firm.

For her part, Ms. Howell said the action was prompted by a desire to better address what she deemed "systemic problems" with "lack of supervision" of stock brokers at Morgan Stanley, in alleged violation of Washington state securities law. She said the matter came to a head when lawyers in the state's attorney general's office "informed us the agreement Deb reached was unenforceable. If Morgan Stanley decided to take steps not to do the things [agreed to], we couldn't do much." This was because the terms themselves were "in a side agreement," she said.

Morgan Stanley disagrees, however, saying it has signed side agreements in the past and the documents are enforceable, a spokesman for the firm said.

The developments underscore state and federal financial regulators' heightened interest in being tough on Wall Street in the wake of numerous scandals over accounting frauds, stock-trading misdeeds and conflict-ridden financial advice that consumer advocates say should have caught regulators' attention sooner.

In the dispute with Morgan Stanley, the regulators maintain that two of its stockbrokers wrongly advised three Microsoft employees to exercise thousands of their Microsoft stock options, then sell some of their Microsoft shares to finance purchases of risky technology and telecommunications stocks, according to a complaint served on the firm by the regulators late last year that has never been made public. The brokers also encouraged the employees to finance some of the investment moves by borrowing against their stock holdings, further amplifying the damage when the stock market dropped, the complaint says. One of the state's biggest concerns was the alleged failure of the firm to better supervise its employees.

Microsoft, based in Redmond, Wash., is one of the state's biggest employers. During the tech boom, the value of many Microsoft employees' options soared. That attracted the attention of many Wall Street brokers, who saw the potential for a windfall in investment advice.

Since the boom went bust, many clients with devastated portfolios have sued, maintaining that the Wall Street firms were too aggressive for their conservative tastes. As the state's director of securities, Ms. Bortner had investigated some of the allegations that Morgan Stanley's brokers wrongly pushed them into unsuitable investments. Some of these cases have gone to securities arbitration and three have received no award. Morgan Stanley, according to a person close to the firm, has settled a handful of other cases for nominal amounts.

Ms. Bortner and Morgan Stanley reached an agreement to resolve the matter last month, and Morgan had begun to implement some of the changes. The firm agreed, among other things, to pay approximately $200,000 and provide additional training for its financial advisers, according to people familiar with the matter. It would neither admit nor deny wrongdoing. The firm, the people say, had signed this agreement. While Washington officials had sent the firm a copy of the pact, the state hadn't signed the document.

Then, late last month Morgan Stanley learned Ms. Bortner had been removed from her job and the deal was off, these people said. "As far as I am concerned, an agreement isn't done until it is signed by both parties," said Ms. Howell. She said the state countered with a stronger settlement offer, but it was rejected by the firm on Friday.

Morgan Stanley is now bracing for Washington State to bring an enforcement action, a much more serious outcome than a settlement agreement, with potentially stiffer penalties. Ms. Howell confirmed this is one of the options she has. But first the matter would go to an administrative hearing, where Morgan Stanley could make its argument against further action.

Morgan Stanley, meanwhile, is considering taking the state to court to force it to uphold the agreement, the people close to the firm said. "We have a legally binding agreement in place with the State of Washington," the Morgan Stanley spokesman said.

Continued in the article

Bob Jensen's threads on investment banking and security analyst frauds are at 

Citigroup agreed to pay $2.65 billion to settle a suit brought by investors of the former WorldCom, who lost billions when the telecom firm filed for Chapter 11. Citigroup said it would take a $4.95 billion charge in the second quarter.

"Citigroup Will Pay $2.65 Billion To Settle WorldCom Investor Suit," by Mitchell Pacelle, The Wall Street Journal, May 11, 2004, Page A1 ---,,SB108419118926806649,00.html?mod=home_whats_news_us 

In one of the largest class-action settlements ever, Citigroup Inc. agreed to pay $2.65 billion to settle a suit brought by investors of the former WorldCom Inc., who lost billions when the telecommunications giant filed for bankruptcy in 2002 after a massive accounting scandal.

The world's largest financial-services firm, facing many other lawsuits tied to its role in other corporate scandals, also announced it was substantially beefing up its reserves earmarked for pending litigation. Following the bank's addition of $5.25 billion pretax to reserves, and the payment of the WorldCom settlement, Citigroup will have $6.7 billion in litigation reserves remaining.

The actions open an expensive new chapter in the bank's continuing clean-up efforts. Coming nearly a year after its last major settlement with regulators, settlement of the WorldCom lawsuit, which stemmed from Citigroup's underwriting of WorldCom securities, suggests that resolving complaints from private investors could be far more costly for the bank than making amends with the government.

The round of corporate and investment-banking scandals that shook the markets in 2001 and 2002 led to a spate of regulatory actions against New York-based Citigroup and other Wall Street titans. In an unprecedented series of pacts last year, Citigroup and other investment banks settled with regulators at a collective cost of more than $1 billion. But lawsuits brought by investors claiming billions of dollars of damages continue to hang over the banking industry.

Citigroup said it would take a second-quarter after-tax charge of $4.95 billion, or 95 cents a share, to cover the settlement and increase in litigation reserves. Other cases facing the company involve financing that it arranged for energy giant Enron Corp. before its collapse and alleged abuses in the way it allocated shares in hot initial public offerings during the stock-market boom.

The WorldCom settlement itself, with certain buyers of WorldCom shares and bonds, will cost Citigroup $1.64 billion after tax, because the $2.65 billion payout is tax deductible, the company said.

The WorldCom lawsuit, certified as a class action on behalf of hundreds of thousands of bond and stock purchasers, alleges that Citigroup and other investment banks that underwrote about $17 billion of WorldCom bonds in May 2000 and May 2001 didn't conduct adequate due diligence before bringing the securities to market. Besides Citigroup, the defendants include 17 other underwriters that handled about two-thirds of the bonds, including J.P. Morgan Chase & Co., Deutsche Bank AG and Bank of America Corp.

The suit also focused in part on Citigroup's Salomon Smith Barney unit and its former star telecommunications analyst Jack Grubman, who was accused of touting WorldCom stock until two months before the telecommunications company collapsed. The lawsuit alleged that Mr. Grubman knew that his public statements about WorldCom, which the suit claims helped drive up the value of the stock, weren't accurate. Mr. Grubman, one of the most influential Wall Street analysts during the tech boom, left Citigroup in August 2002 amid allegations of conflict of interest.

WorldCom filed for bankruptcy protection in July 2002, and recently emerged from court protection under the name of MCI Corp. Its former bondholders received new stock and bonds, but its former shareholders received nothing.

Citigroup and Mr. Grubman, as well as other defendants in the suit, have previously denied the accusations. Citigroup didn't admit to any wrongdoing under the settlement Monday.

"I personally believe we did not participate in any way in fraudulent activities," Citigroup's chief executive, Charles Prince, said Monday. But in light of "the current litigation environment," he said, "I was not willing to roll the dice for the stockholders to try to score a big win."

The plaintiffs, led by the New York State Common Retirement Fund, described the settlement with Citigroup as the second-largest securities class action settlement ever, after a $3.2 billion settlement against Cendant Corp. in 2000, but the largest against a third party in connection with work conducted for a corporate wrongdoer. MCI wasn't a party to the settlement.

Continued in article

Bob Jensen's threads on the Worldcom and Andersen scandals are at 

This is old news, but it does provide some questions for students to ponder.  The main problem of fair value adjustment is that many ((most?) of the adjustments cause enormous fluctuations in earnings, assets, and liabilities that are washed out over time and never realized.  The main advantage is that interim impacts that “might be” realized are booked.  It’s a war between “might be” versus “might never.”  The war has been waging for over a century with respect to booked assets and two decades with respect to unbooked derivative instruments, contingencies, and intangibles.

As you can see below, the war is not over yet.  In fact it has intensified between corporations (especially banks) versus standard setters versus members of the academy.

From The Wall Street Journal Accounting Educators' Review on April 2, 2004

TITLE: As IASB Unveils New Rules, Dispute With EU Continues 
REPORTER: David Reilly 
DATE: Mar 31, 2004 
PAGE: A2 LINK:,,SB108067939682469331,00.html  
TOPICS: Generally accepted accounting principles, Fair Value Accounting, Insider trading, International Accounting, International Accounting Standards Board

SUMMARY: Despite controversy with the European Union (EU), the International Accounting Standards Board (IASB) is expected to release a final set of international accounting standards. Questions focus on the role of the IASB, controversy with the EU, and harmonization of the accounting standards.

1.) What is the role of the IASB? What authority does the IASB have to enforce standards?

2.) List three reasons that a country would choose to follow IASB accounting standards. Why has the U.S. not adopted IASB accounting standards?

3.) Discuss the advantages and disadvantages of harmonization of accounting standards throughout the world. Why is it important the IASB reach a resolution with the EU over the disputed accounting standards?

4.) What is fair value accounting? Why would fair value accounting make financial statements more volatile? Is increased volatility a valid argument for not adopting fair value accounting? Does GAAP in the United States require fair value accounting? Support your answers.

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

Bob Jensen's threads on these controversial standards are at 

Also note 

Bob Jensen's threads on accounting theory are at 

Those threads dealing with fair value are at 

"U.S. Looking at Citigroup's Accounting in Argentina," by Timothy L. O'Brien, The New York Times, May 6, 2004 --- 

Citigroup said yesterday that the Securities and Exchange Commission was investigating possible accounting irregularities related to its banking business in Argentina from 2001 to 2003, a period when Citigroup was plagued by huge loan losses and Argentina was grappling with political and economic turmoil.

Citigroup disclosed the investigation in a quarterly earnings report filed with the S.E.C. yesterday and said the agency planned to begin hearing nonpublic testimony on the matter this month - a move that suggests that the inquiry is more than just a routine examination of the bank's accounting practices.

Citigroup said in its filing that the investigation "originated with the company's accounting treatment regarding its investments and business activities, and loan loss allowances, with respect to Argentina" in the fourth quarter of 2001 and the first quarter of 2002.

The investigation is examining "the timing and support documentation for certain accounting entries or adjustments," the company said. It also said that the S.E.C. "requested certain accounting and internal controls-related information" regarding the booking of Argentine transactions in 2001, 2002 and 2003.

Citigroup said it was cooperating with the investigation but declined to comment on the matter beyond what it disclosed in its securities filing. The S.E.C. also declined to comment.

Argentina has long been a centerpiece of Citigroup's Latin American operations, and the company has enjoyed close relationships with the country's leading financiers, businessmen and political elite. The bank played a pivotal role in the country's sweeping privatizations in the 1990's and has been a leading player in Argentine industries as diverse as financial services, telecommunications, real estate and electronic media.

After the Argentine economy and currency went into a tailspin in 2001, the country defaulted on a portion of about $140 billion in public debt. To deal with the crisis, the country, which had previously tried to combat rampant inflation by linking its currency to the dollar, abandoned that experiment and converted some of its dollar-denominated debt to Argentine pesos. For several weeks, the banking system shut down and the peso stopped trading on currency markets.

The economic downturn, the default and the currency conversion all combined to leave Argentina's lenders on the hook for billions of dollars. Citigroup was among them. In the fourth quarter of 2001 and the first quarter of 2002, the bank took more than $1.2 billion in pretax charges for bad loans and other losses in Argentina. The bank, the world's largest, ultimately wrote off about $2 billion in soured Argentine loans and investments.

Poor planning and overly aggressive lending on Citigroup's part also played a role in the loan losses. Victor J. Menezes, who headed Citigroup's emerging markets business at the time, was stripped of those duties because of the Argentine losses.

Continued in the article.


How the Gatekeepers Failed in Their Responsibilities to Protect the Public from Corporate and Banking Fraud

Brooksley Born, chair of the Commodity Futures Trading Commission --- suggested that government should at least study whether some regulation might make sense, a stampede of lobbyists, members of Congress, and other regulators --- including Alan Greenspan and Robert Rubin --- ran her over, admonishing her to keep quiet.  Derivatives tightened the connections among various markets, creating enormous financial benefits and making global transacting less costly --- no one denied that.  But they also raised the prospect of a system-wide breakdown.  With each crisis, a few more dominos fell, and regulators and market participants increasingly expressed concerns about systematic risk --- a term that described a financial-market epidemic.  After Long-Term Capital collapsed, even Alan Greenspan admitted that the financial markets had been close to the brink.  
Frank Partnoy, Infectious Greed (Henry Holt and Company, 2004, Page 229)

Throughout 1994 and 1995, Brickell (the banking industry's pit bull in Washington) and Levitt (Head of the SEC) worked to protect the finance industry from new legislation.  In early 1994, lobbyists waited for investors to calm down from the shock of how much money-fund managers and corporate treasures had lost gambling on interest rates.  When legislation was introduced, Brickell fought it and Levitt gave speeches saying the financial industry should police itself.  The issues were complicated, and the public --- once angered by the various scandals ---  ultimately lost interest.  Instead of new derivatives regulation, Congress, various federal agencies, and even the Supreme Court created new legal rules that insulated Wall Street from liability and enabled financial firms to regulate themselves.   Under the influence of Levitt and Brickell, regulators essentially left the abuses of the 1990s to what Justice Cardozo had called the "morals of the market place."
Frank Partnoy, Infectious Greed (Henry Holt and Company, 2004, Page 143)

One of the world's most widely known and respected economists, Henry Kaufman is almost single-handedly responsible for founding the spectator sport known as "Fed watching." He began a 26-year career at Salomon Brothers in 1962, when he was probably the only Wall Street employee with a doctorate. There he built one of the most prestigious securities research departments and became a senior partner and vice chairman. In the last 30 years, he has been one of the most vocal critics of insufficient financial oversight and regulation, and his pronouncements and prognostications have often moved markets. We interviewed Dr. Kaufman in his New York office, where he heads his own international economic consulting firm.
Wall Street Wisdom --- 

"Remarks by Chairman Alan Greenspan Before a conference sponsored by the Office of the Comptroller of the Currency, Washington, D.C. October 14, 1999 --- 

Measuring Financial Risk in the Twenty-first Century

During a financial crisis, risk aversion rises dramatically, and deliberate trading strategies are replaced by rising fear-induced disengagement. Yield spreads on relatively risky assets widen dramatically. In the more extreme manifestation, the inability to differentiate among degrees of risk drives trading strategies to ever-more-liquid instruments that permit investors to immediately reverse decisions at minimum cost should that be required. As a consequence, even among riskless assets, such as U.S. Treasury securities, liquidity premiums rise sharply as investors seek the heavily traded "on-the-run" issues--a behavior that was so evident last fall.

As I have indicated on previous occasions, history tells us that sharp reversals in confidence occur abruptly, most often with little advance notice. These reversals can be self-reinforcing processes that can compress sizable adjustments into a very short period. Panic reactions in the market are characterized by dramatic shifts in behavior that are intended to minimize short-term losses. Claims on far-distant future values are discounted to insignificance. What is so intriguing, as I noted earlier, is that this type of behavior has characterized human interaction with little appreciable change over the generations. Whether Dutch tulip bulbs or Russian equities, the market price patterns remain much the same.

We can readily describe this process, but, to date, economists have been unable to anticipate sharp reversals in confidence. Collapsing confidence is generally described as a bursting bubble, an event incontrovertibly evident only in retrospect. To anticipate a bubble about to burst requires the forecast of a plunge in the prices of assets previously set by the judgments of millions of investors, many of whom are highly knowledgeable about the prospects for the specific investments that make up our broad price indexes of stocks and other assets.

Nevertheless, if episodic recurrences of ruptured confidence are integral to the way our economy and our financial markets work now and in the future, the implications for risk measurement and risk management are significant.

Probability distributions estimated largely, or exclusively, over cycles that do not include periods of panic will underestimate the likelihood of extreme price movements because they fail to capture a secondary peak at the extreme negative tail that reflects the probability of occurrence of a panic. Furthermore, joint distributions estimated over periods that do not include panics will underestimate correlations between asset returns during panics. Under these circumstances, fear and disengagement on the part of investors holding net long positions often lead to simultaneous declines in the values of private obligations, as investors no longer realistically differentiate among degrees of risk and liquidity, and to increases in the values of riskless government securities. Consequently, the benefits of portfolio diversification will tend to be overestimated when the rare panic periods are not taken into account.

The uncertainties inherent in valuations of assets and the potential for abrupt changes in perceptions of those uncertainties clearly must be adjudged by risk managers at banks and other financial intermediaries. At a minimum, risk managers need to stress test the assumptions underlying their models and set aside somewhat higher contingency resources--reserves or capital--to cover the losses that will inevitably emerge from time to time when investors suffer a loss of confidence. These reserves will appear almost all the time to be a suboptimal use of capital. So do fire insurance premiums.

The above is only a quotation from the speech.

UNEQUAL TREATMENT:  Rotten to the Core

"Playing Favorites:  Why Alan Greenspan's Fed lets banks off easy on corporate fraud," by Ronald Fink, CFO Magazine, April 2004, pp. 46-54 ---,5309,12866||M|886,00.html 

The module below is not in the above online version of the above article.  However, it is on Page 51 of the printed version.


IF THE FEDERAL RESERVE BOARD AND THE SECURITIES AND EXCHANGE Commission pursue the same agenda, why were Merrill Lynch & Co. and the Canadian Imperial Bank of Commerce (CIBC) treated so differently by the Corporate Fraud Task Force--a team with representatives from the SEC, the FBI, and the Department of Justice (DoJ) set up to prosecute perpetrators of Enron's fraud--than were Citigroup and J. P. Morgan Chase & Co.?  After all, all four banks did much the same thing.

Under settlements signed with the SEC last July, Citigroup and Chase were fined a mere $101 million (including $19 million for its actions relating to a similar fraud involving Dynegy) and $135 million, respectively, which amounts to no more than a week of either's most recent annual earnings.  And they agreed, in effect, to cease and desist from doing other structured-finance deals that mislead investors.  That contrasts sharply with the punishment meted out by the DoJ to Merrill and CIBC, each of which not only paid $80 million in fines, but also agreed to have their activities monitored by a supervising committee that reports to the DoJ.  Even more striking, CIBC agreed to exit not only the structured-finance business but also the plain-vanilla commercial--paper conduit trade for three years.  No regulatory agency involved in the settlements would comment on the cases, though the SEC's settlement with Citigroup took note of the bank's cooperation in the investigation.

But Brad S. Karp, an attorney with the New York firm Paul, Weiss, Rifkind, Wharton & Garrison LLP, suggested recently that the terms of the SEC settlement with its client, Citigroup, reflected a lack of knowledge or intent on the bank's part.  As Karp noted more than once at a February conference on legal issues and compliance facing bond-market participants, the SEC's settlement with Citigroup was ex scienter, a Latin legal phrase meaning "without knowledge."

However, the SEC's administrative order to Citigroup cited at least 13 instances where the bank was anything but in the dark about its involvement in Enron's fraud.

As Richard H. Walker, former director of the SEC's enforcement division and now general counsel of Deutsche Bank's Corporate and Investment Bank, puts it, all the banks involved in Enron's fraud "had knowledge" of it.  Yet Walker isn't surprised by their disparate treatment at the hands of regulators.  "The SEC does things its way," he says, "and the Fed does them another."  *Ronald Fink and Tim Reason

Bob Jensen's threads on "Rotten to the Core" are at 

Bob Jensen's threads on Derivative Financial Instruments fraud are at 

IASB Finalises Macro Hedging Amendments to IAS 39 March 31, 2004 --- 

The International Accounting Standards Board (IASB) issued an Amendment to IAS 39 Financial Instruments: Recognition and Measurement on Fair Value Hedge Accounting for a Portfolio Hedge of Interest Rate Risk. The amendments simplify the implementation of IAS 39 by enabling fair value hedge accounting to be used more readily for a portfolio hedge of interest rate risk (sometimes referred to as a macro hedge) than under previous versions of IAS 39.

The publication of this amendment is a direct response to concerns expressed by the banking community about the potential difficulty of implementing the requirements of IAS 39. Many constituents had sought fair value hedge accounting treatment for portfolio hedging strategies, which was not previously permitted under IAS 39. In the light of these concerns, the IASB launched intensive discussions with representatives of the banking industry to determine whether a way could be found within the existing principles of IAS 39 to allow fair value hedge accounting treatment to be applied to a macro hedge.

The publication of this amendment means that macro hedging will be part of the IASB’s set of standards to be adopted in 2005. The IASB notes that discussions will continue on another aspect of IAS 39, namely an additional hedging methodology and the balance sheet presentation of certain hedges—issues of particular concern to some banking institutions. Furthermore, in April, the IASB will publish a proposed limited amendment to restrict the existing fair value option in response to concerns raised by banking supervisory authorities.

With today’s publication of the macro-hedging amendment, the IASB announced its intention to set up an international working party to examine the fundamentals of IAS 39 with a view to replacing the standard in due course. (A similar working party will be established on the IASB’s long-term insurance project.) The financial instruments working party will assist in improving, simplifying and ultimately replacing IAS 39 and examine broader questions regarding the application and extent of fair-value accounting—a topic on which the IASB has not reached any conclusion. Although any major revision of IAS 39 may take several years to complete, the IASB is willing to revise IAS 39 and IFRS 4 Insurance Contracts in the short term in the light of any immediate solutions arising from the working parties’ discussions. The IASB plans to announce details of these two working parties in the coming weeks.

Introducing the amendment to IAS 39, Sir David Tweedie, IASB Chairman, commented:

This amendment is a further step in our project to ease the implementation of IAS 39 for the thousands of companies required to implement international standards in 2005 and those companies already using IFRSs. The IASB has made it clear that any amendments must be within the basic principles of hedge accounting contained in IAS 39, but that we will work within those principles to simplify the application of the standard. This amendment does not mark the end of the Board’s work on the subject of financial instruments. The Board remains open to all suggestions for improvement of the standard and is taking active steps in both the immediate future and in the medium term to that end.
The primary means of publishing International Financial Reporting Standards is by electronic format through the IASB’s subscriber Website. Subscribers are able to access the amendment published today through “online services”. Those wishing to subscribe should contact:

Printed copies of Amendment to IAS 39 Financial Instruments: Recognition and Measurement: Fair Value Hedge Accounting for a Portfolio Hedge of Interest Rate Risk (ISBN 1-904230-58-X) will be available shortly, at £15 each including postage, from IASCF Publications Department.

Bob Jensen's threads on macro hedging are at 

I have previously reported everything in Mike's message below, but he puts it into plain English.

March 31, 2004 message from Mike Gasior --- 


This is a topic where I want to be quite brief and completely efficient. About three years ago a new accounting rule took effect in the United States you will hear referred to as "FAS 133". This accounting standard dramatically changed the way companies reported their derivative holdings, and the idea was to make financial statements more transparent and more realistic. While I was not completely in favor of the ruling by FASB and believed the new rule had many flaws, it was at least progress in the right direction. For this reason I tried to stay open minded about it.

As many of my readers know, the derivatives marketplace has grown to an enormous size and knows no borders. Companies and financial institutions the world over enter into a vast array of derivative contracts each and every business day. One concern for all these participants has been understanding the financial status and condition of the party you are entering into these contracts with. Given that the rest of the world does not follow U.S. GAAP accounting, the hope has been that some of the other major economies would adopt standards similar to the U.S. FAS 133 to allow a more "apples to apples" type of comparison between parties. We were about to get that continuity in Europe with the adoption of IAS 32 and IAS 39, which would have brought much global reporting into line with FAS 133 and make the markets more transparent. By the way, the FAS stands for "Financial Accounting Standard" and the IAS for "International Accounting Standard".

But here comes our friends at the EU, bowing to pressure from a variety of European banks (particularly the French) that are mortified at the idea of having to mark their derivative holdings to market and reflecting the changed value on their balance sheets the way U.S. companies are now forced to do. The plan was for IAS 32 and IAS 39 to take effect in 2005, but now it appears the implementation will be at least delayed. If not cancelled altogether.

I'm not going to insult your intelligence by re-telling you my opinion of the Microsoft ruling by the EU, but you tell me how this accounting situation is much different. If behavior like this continues, where political pressures cause the playing field to always be shifted away from U.S. companies, I can guarantee you the U.S. will lash out with legislation of their own and it will not be a pretty sight.

Please don't read any sort of political inferences into what I am saying. I always try to take an economic approach to matters such as these, but that doesn't make me a fool. It will be an economic disaster as protectionist walls begin to go up around the world for everyone involved. But U.S. companies and U.S. politicians are not going to sit still either while other countries whittle away the ability of the U.S. to compete abroad. My suggestion to these countries is improve your markets and products to better compete with your American competitors. If your so afraid to compete on a level playing field you will give the U.S. no choice but tilt their own field to your disadvantage.

Bob Jensen's threads on FAS 133 and IAS 39 are at 

"SEC May Police Fair-Value Pricing," by Tom Lauricella, The Wall Street Journal, April 26, 2004 ---,,SB108292923140792834,00.html?mod=home%5Fwhats%5Fnews%5Fus 

Agency Is Weighing Move To Take Disciplinary Action Against Errant Fund Firms

The Securities and Exchange Commission for the first time is weighing bringing disciplinary actions against mutual-fund companies that have failed to use so-called fair-value pricing for portfolio holdings with out-of-date market prices, agency officials said.

The SEC investigations into fair-value pricing practices at an undisclosed number of fund companies are still in the preliminary stages, the officials cautioned. But any resulting disciplinary efforts would open another front in the SEC's expanded scrutiny of the fund industry and signal that the agency is attaching greater importance to fair-value techniques in the wake of the share-trading scandal.

Fair-valuation practices involve using estimates to set the value of portfolio holdings when the securities' closing market prices become out of date because of later developments. Such mispricing is particularly an issue for U.S. mutual funds holding foreign stocks whose closing values are hours old by the time the funds calculate their share prices at the end of trading for U.S. markets. Funds using such out-of-date prices have been targets of market timers, who are short-term traders who profit by rapidly buying and selling fund shares to the detriment of long-term fund investors.

The SEC approved fair-value techniques in 1981 and strongly recommended funds use them, but the agency never directly required funds to adopt such pricing methods. However, under other SEC rules, funds have an obligation to make sure their share prices are as accurate as possible after events such as major swings in U.S. markets after the close of overseas stock trading.

As a result, agency officials said the SEC investigation is focusing on whether funds in such circumstances violated their obligations to set the most accurate share prices possible if they didn't consider using fair-value techniques.

Some experts think the probe will result in disciplinary charges if a fund didn't consider using fair-value practices. "It wouldn't surprise me to see them bring a case," says Barry Barbarsh, a former top SEC official now at Shearman & Sterling. The notion that the SEC has wanted funds to make greater use of fair-value techniques "has been out there for a while," he said.

The prospect of new allegations is an added headache for the fund industry that has been enveloped in scandal for seven months because of share-trading abuses as well as cases involving the misuse of investors' money in promoting the sales of funds. Fund companies have already been hit with $1.7 billion in fines and numerous top executives have lost their jobs.

While substituting estimates for market prices can be controversial, the SEC has long held that the practice is preferable to using outdated market prices in setting portfolio values. In 1997, Fidelity Investments drew criticism from some investors when it used fair-value pricing on some of its international stock funds during the turmoil of the Asian financial crisis. The SEC backed Fidelity's actions, but the practice still hasn't been widely adopted throughout the industry, often because fund officials worry that using fair-value pricing could open the door to lawsuits.

But the SEC, in an April 2001 letter to the Investment Company Institute, the fund industry's main trade group, spelled out that funds had an obligation to set internal policies covering fair-value pricing. Specifically, the SEC said that "funds should continuously monitor for events that might necessitate the use of fair-value prices."

Since disclosures of widespread market timing in the fund industry, fair-value pricing has received added attention. Many observers contend that employing fair-value techniques is the best method for combating outdated prices exploited by fund market timers.

Continued in the article

Bob Jensen's threads on the mutual fund scandals are at 

U.S. Government Accountability

Earlier this year the GAO was unable for a sixth consecutive year to express an opinion as to whether the U.S. government’s consolidated financial statements were fairly stated.

The bottom line is that, in my view, the federal government’s current financial statements and annual reports do not give policy makers and the American people an adequate picture of our government’s overall performance and true financial condition. This is a serious issue. As Thomas Jefferson noted, an informed electorate is the basis for a sound democracy. But how can the American people and their elected officials make sound decisions if they aren’t given timely, accurate and useful information?
The Honorable David M. Walker (U.S. Comptroller General), "Truth and Transparency:  The Federal Government's Financial Condition and Fiscal Outlook, Journal of Accountancy, April 2004, pp. 26-31 --- 

Let me review the federal government’s current financial condition; its fiscal 2002 annual financial report says a lot but not enough. The good news is that as of September 30, 2002, we had about $1 trillion in reported assets. The bad news is that we had almost $8 trillion in reported liabilities. That left us with about a $7 trillion accumulated deficit, or a little more than $24,000 for every man, woman and child in the United States. In fiscal year 2002, the federal government reported a net operating deficit of $365 billion. Many of you may be more familiar with the unified budget deficit number, which in fiscal year 2002 was $158 billion. Irrespective of whether you focus on the accrual-based accounting numbers or the cash-based budget numbers, the picture isn’t good and it’s getting worse. For example, the Congressional Budget Office [CBO] projects that the unified budget deficits in fiscal years 2003 and 2004 will be $401 billion and $480 billion, respectively. These numbers are up significantly from fiscal year 2002. Interestingly, CBO estimates that we will incur about $157 billion in interest on publicly held federal debt in fiscal year 2003 even though current interest rates are low on a relative basis. CBO also estimates that, excluding Social Security surpluses, the total deficit for fiscal years 2003 and 2004 will be $562 billion and $644 billion, respectively. If all these numbers are making your head spin, just remember that they are all big, and they are all bad.

More important, although we know that we are in a financial hole, we don’t really have a very good picture of how deep it is. Several very significant items are not currently included as liabilities in the federal government’s financial statements. These items include several trillion dollars in nonmarketable government securities in the so-called “trust funds.” In the case of the Social Security and Medicare trust funds, the federal government took in taxpayer money, spent it on other items and replaced it with an IOU. Given this fact, the amounts attributed to such activities aren’t shown as a liability of the U.S. government. Does this make sense, especially when the government continues to tell Social Security and Medicare beneficiaries that they can count on the bonds in these “trust funds?” Is the federal government trying to have its cake and eat it too?

The current liability figures for the U.S. government also do not adequately consider veterans’ health care benefit costs provided through the Department of Veterans Affairs, nor do they include the difference between future promised and funded benefits from the Social Security and Medicare programs. These additional amounts total tens of trillions of dollars in discounted present value terms. Simply put they are likely to exceed $100,000 in additional burden for every man, woman and child in America today, and these amounts are growing every day. These items may or may not ultimately be considered to be liabilities from an accounting perspective, but they do represent significant commitments that will have to be addressed. The burden of paying for these is not a very nice present for a child born today. Personally, I’d prefer a savings bond rather than a bill.

In fairness the federal government’s financial statements also exclude some assets and rights held by the government. For example, the financial statements do not acknowledge the federal government’s power to tax. The U.S. government owns and controls one out of every four acres of the U.S. landmass. Yet the financial statements do not include any asset value for so-called stewardship or heritage assets, such as public lands and monuments, or national defense assets, such as missiles, tanks, ships and planes. These items were acquired at a cost and have some value, but do we really ever expect to sell them? For the most part, the answer is no.

Beyond financial information the federal government as a whole and each federal department and agency need to be able to show the results they have achieved with the resources and authorities they have been given. I’m not talking about performance measurement in a narrow sense but about whether agencies can show they are making a difference towards meeting the needs of society. This type of performance information and related cost/benefit analyses needs to become a standard part of federal reporting and operations. Unfortunately, for the most part, this is not being done adequately.

The bottom line is that, in my view, the federal government’s current financial statements and annual reports do not give policy makers and the American people an adequate picture of our government’s overall performance and true financial condition. This is a serious issue. As Thomas Jefferson noted, an informed electorate is the basis for a sound democracy. But how can the American people and their elected officials make sound decisions if they aren’t given timely, accurate and useful information?

The recent accountability failures in the private sector underscore the importance of proper accounting and reporting practices. It is critically important that such failures not be allowed to occur in the public sector. We at the GAO are dedicated to ensuring they don’t occur and to furthering progress on these and other important transparency and accountability issues. Earlier this year the GAO was unable for a sixth consecutive year to express an opinion as to whether the U.S. government’s consolidated financial statements were fairly stated. We were unable to express an opinion primarily because of serious financial management problems at the Defense Department, the government’s inability to adequately account for intragovernmental transactions and the government’s inability to properly prepare consolidated financial statements. Despite this track record I believe that, as 21 of 24 major federal agencies do, the federal government can and ultimately will receive an unqualified opinion on its financial statements, it’s hoped well before my term ends in 2013. At the same time I can assure you the U.S. government will not receive an opinion on its financial statements from the GAO until it earns one.

Continued in the article

The GAO --- 

The General Accounting Office is the audit, evaluation, and investigative arm of Congress. GAO exists to support the Congress in meeting its Constitutional responsibilities and to help improve the performance and ensure the accountability of the federal government for the American people. GAO examines the use of public funds, evaluates federal programs and activities, and provides analyses, options, recommendations, and other assistance to help the Congress make effective oversight, policy, and funding decisions. In this context, GAO works to continuously improve the economy, efficiency, and effectiveness of the federal government through financial audits, program reviews and evaluations, analyses, legal opinions, investigations, and other services. GAO's activities are designed to ensure the executive branch's accountability to the Congress under the Constitution and the government's accountability to the American people. GAO is dedicated to good government through its commitment to the core values of accountability, integrity, and reliability.

Advancing Governmental Accounting ---

April 17, 2004 message from Wanda Wallace []

Dear Bob,

I thought I'd also pass along another piece of news. I recently completed a writing project that in my mind's eye has among its audiences the classroom. In particular, in the introductory undergraduate, graduate, EMBA, and continuing education areas, I do not believe there has been a short, easy-to-read, primer available on the rudiments of internal control and auditing. In these times, everyone seems a bit more interested in gaining such a foundation, and I have had the good fortune of working with the AGA to bring the book to fruition. Since this is the first book that association has published, I am taking the time to try to "get the word out" with some individuals with whom I'm acquainted in academia. In any case, should you have an interest in the site (which was posted just last week), see ( ) and (  )

I hope all is well.



Wanda A. Wallace, Ph.D., CPA, CMA, CIA
Williamsburg, Virginia

"Pfizer to Pay $420 Million in Illegal Marketing Case," by Gardiner Harris, The New York Times, May 14, 2004 --- 

Pfizer, the world's largest pharmaceutical company, pleaded guilty yesterday and agreed to pay $430 million to resolve criminal and civil charges that it paid doctors to prescribe its epilepsy drug, Neurontin, to patients with ailments that the drug was not federally approved to treat.

Of that settlement, $26.64 million will go to a former company adviser who brought a lawsuit under a federal "whistleblower" law.

The company encouraged doctors to use Neurontin in patients with bipolar disorder, a psychological condition, even though a study had shown that the medicine was no better than a placebo in treating the disorder. Other disorders for which the company illegally promoted Neurontin included Lou Gehrig's disease, attention deficit disorder, restless leg syndrome and drug and alcohol withdrawal seizures.

Although doctors are free to prescribe any federally approved drug for whatever use they choose, pharmaceutical companies are not allowed to promote drugs for nonapproved purposes. Neurontin was initially approved to treat epileptic seizures in patients who had failed to improve using other treatments, but it has become one of the biggest-selling drugs in the world, with sales last year of $2.7 billion. Nearly 90 percent of the drug's sales continue to be for ailments for which the drug is not an approved treatment, according to recent surveys.

"This illegal and fraudulent promotion scheme corrupted the information process relied upon by doctors in their medical decision-making, thereby putting patients at risk," said the United States attorney in Boston, Michael Sullivan, in a statement yesterday.

Pfizer, in a statement yesterday, said that the illegal marketing had been conducted by Warner-Lambert before Pfizer acquired that company in 2000.

"Pfizer has cooperated fully with the government to resolve this matter, which did not involve Pfizer practices or employees," the company said.

Pfizer took a $427 million charge in January against its fourth-quarter 2003 earnings to pay for the expected settlement. The government calculated that the company's illegal promotions brought it $150 million in ill-gotten gains. A standard multiplier was used to come up with the $430 million fine.

The case is one of many undertaken in recent years by federal prosecutors in Boston and Philadelphia who are examining efforts by drug companies to market their drugs for unapproved uses and pay doctors for prescriptions. And while the pharmaceutical industry recently adopted voluntary guidelines that have eliminated many of the gifts and payments once routinely dispensed to doctors, the industry's aggressive promotions continue.

Bob Jensen's threads on corporate fraud are at 

NEWS ALERT: brought to you by Ethical Performance in association with Just Assurance, May 6, 2004 --- Ethical Performance [

Operating and Financial Reviews will be required from next year

Quoted UK companies will have to begin producing Operating and Financial Reviews that take account of their social and environmental performance from next year, according to a draft regulation published today (Wednesday 5 May) by the government.

The long-awaited regulation would require around 1290 British-based companies listed on the London, New York and Nasdaq stock exchanges to produce OFRs for all shareholders for financial years beginning on or after 1 January 2005 or face unlimited fines.

The regulation says the OFRs should be published separately from annual reports and standalone social and environmental reports, at an estimated average cost of around £29,000 (USD 51,000) per company.

It says OFRs should include details of a company's objectives and strategies, and provide information on 'a wide range of factors which may be relevant to an understanding of the business, such as information about employees, environmental matters and community and social issues'.

OFRs will fall within the remit of The Accounting Standards Board, which oversees UK financial reporting standards. The board is to publish draft standards for OFR reporting in the second half of 2004, and will finalize these in 2005.

Although the regulation theoretically gives directors the discretion to decide that social and environmental information is not material to their company's OFR, it is made clear that such information is expected. The regulation specifies that if a company reports nothing on these areas, then it must make an explicit statement to that effect.

The draft regulation is now out to consultation until 6 August. Guidance on how companies should decide what is relevant to include in the reviews has also been published.

The government says it will review OFRs after five years with a view to widening the requirement to other companies.

Lucy Candlin and Adrian Henriques of the UK-based assurance provider justassurance comment:

"The requirement for publication by quoted companies of a forward-looking review that accounts for both financial and non-financial performance, has the potential to make it easier to analyse the long-term sustainability of a business. This is in the interests of both the company and its investors. An OFR will help to identify social and environmental factors that may affect the company's performance in the long term and those which might be seen as in conflict with the short-term interests of shareholders. But the key question is, will these reviews strengthen engagement and disclosure by companies?

The regulation is potentially a good framework for those companies intending to report on their 'wider impacts', including non-quoted companies, but it also offers a hiding place for those with no such intention. The OFR will be the director's view of the relevant and significant issues that may be of interest to shareholders, and thus falls short of accountability in its broadest sense. The accompanying Practical Guidance is similarly open to broad interpretation.

In our experience, organizations that are not already engaged in the CSR and accountability debate, for example by using a framework for engaging with stakeholders, are likely to require education and support at all levels of the company if they are to review adequately risks and opportunities. This makes the timetable a particular concern: quality engagement with external stakeholders takes time, yet the regulation will be in force from January 2005.

Furthermore, although the process of determining OFR content will be audited, the question arises of the competence of traditional financial auditors to express a positive opinion on the processes required to establish an understanding of the social and environmental issues affecting a company. They are likely to have to incorporate professional CSR expertise within audit teams in order to ensure that the mechanisms underlying the OFR provide appropriate levels of accountability by taking account of the views of all stakeholders."

justassurance is a UK-based social enterprise working to promote and deliver performance reporting and assurance involving stakeholders. For more information, please contact or visit

Bob Jensen's threads on proposed reforms are at --- 

"White-collar cons tell what led to crimes," Aïssatou Sidimé, San Antonio Express News, April 19, 2004, Page 1E --- 

Quote 1
When he was 32 years old, Walt Pavlo stole $6 million from his then employer, telecommunications giant MCI. He and three cohorts served from 18 months to six years in federal prison. Pavlo must repay at least $800,000.

Karen Bond took $880,000 owned by two elderly sisters who were longtime family friends by funneling it through her Ohio law firm. She was sentenced to 38 months in prison and must repay the money.

In cautionary tales told while on probation, Bond and Pavlo have advice for those with assets: It pays to be constantly vigilant of financial caretakers and corporate executives.

White-collar crimes accounted for about 18 percent of all federal convictions in 2001, according to the U.S. Sentencing Commission. Almost two-thirds were for fraud, with the rest including embezzlement, forgery, counterfeiting, tax law evasion and money laundering.

Pavlo says his theft was the result of working in an amoral corporate culture that stressed meeting ever-higher performance goals by any means in the mid-1990s.

Quote 2

Karen Bond got into trouble when her Type A personality, often prized in the business world, ran amok.

In 1997, a client asked Bond to manage almost $880,000 of assets in exchange for caring for the client, who was in her 90s, and the client's octogenarian sister, who had Alzheimer's disease. With part of the money, Bond said she bought a house where they all lived for two years.

Then her control-oriented personality began to interact with her undiagnosed bipolar disorder.

"No one in the manic phase should be in charge of anything, let alone someone's assets," Bond, 47, said.

The sisters eventually moved to a nursing home, while Bond bought five cars and $24,000 in jewelry, including an $11,000 diamond, and took seven trips in one year. She also used $45,000 for office and personal items, according to a Columbus (Ohio) Dispatch article.

In 1999, she surrendered four of the five cars, the house and her license to practice law in Ohio and pleaded guilty to interstate securities fraud.

While in prison camps in Fort Worth and Kentucky, Bond said she met other white-collar criminals, some with professional degrees, who'd committed mail fraud, tax evasion and insurance fraud. Some exhibited mental illness much like her own.

"Companies need to pay attention to the mental health of employees," she said.

In the past, white-collar criminals were encouraged by light sentences and special prisons that housed them, said federal white-collar defense attorney Douglas McNabb, who's defended dozens in several states.

"They didn't want to get caught but knew that if they did they would be going to some place cushy," he said.

Quote 3
In almost every white-collar crime conviction, the defendant pleads guilty, according to the Bureau of Justice Statistics. They average about two years in federal prison camps, where the nicest ones have no bars, fences or barbed wire and allow prisoners to work in towns. An Oklahoma camp had an 18-hole golf course. A New York facility has a kosher kitchen.

Tougher sentencing guidelines passed down last November should nix any future incentives, McNabb said. Now most white-collar criminals won't be able to get into the camps without first going to standard prisons, and sentences run much longer for crimes committed after Nov. 1, 2001.

But the best deterrent comes from aggressive internal and external monitoring, Bond and Pavlo said.

Top managers should spend time talking with senior managers, stressing and modeling ethical behavior and adjusting performance goals to meet reality, Pavlo said.

"There was an assumption that you knew right from wrong, but it was not reflected in business practices because we were definitely bending every accounting rule," he said of MCI. "Every employee is capable of this. They all have a breaking point if left alone, isolated, and they're asked to compromise something within themselves."

Bob Jensen's threads on white collar crime are at 

A FeloniousParent Takes on the Name of Its Juvenile Delinquent Child

"Worldcom Changes Its Name and Emerges From Bankruptcy," by Kenneth N. Gilpin, The New York Times, April 20, 2004 --- 

Worldcom Inc. emerged from federal bankruptcy protection this morning with the new name of MCI, about 21 months after the scandal-tainted company sought protection from creditors in the wake of an $11 billion accounting fraud.

"It really is a great day for the company," Michael D. Capellas, MCI's president and chief executive, said in a conference call with reporters. "We come out of bankruptcy with virtually all of our core assets intact. But it's been a marathon with hurdles."

The bankruptcy process has allowed MCI to dramatically pare its debt from $41 billion to about $6 billion. And although that cutback will reduce debt service payments by a little more than $2 billion a year, the company still faces some hurdles in its comeback effort.

In addition to changing its new name, the company added five people to its board.

Richard Breeden, the former chairman of the Securities and Exchange Commission who serves as MCI's court-appointed monitor, has imposed some restrictions on board members to make their actions more transparent. Those include a requirement that directors give two weeks' notice before selling MCI stock.

Even though MCI has emerged from bankruptcy, Judge Jed S. Rakoff, the federal district judge who oversaw the S.E.C.'s civil lawsuit against the company, has asked Mr. Breeden to stay on for at least two years.

For the time being, MCI shares will trade under the symbol MCIAV, which has been the symbol since the company went into bankruptcy.

Peter Lucht, an MCI spokesman, said it will be "several weeks, not months" before MCI lists its shares on the Nasdaq market.

In early morning trading, MCIAV was quoted at $18, down $1.75 a share.

It was just about a year ago that Worldcom unveiled its reorganization plan, which included moving its headquarters from Clinton, Miss., to Ashburn, Va., and renaming the company after its long-distance unit, MCI.

Worldcom had merged with MCI in a transaction that was announced in 1997.

Although its outstanding debt has been dramatically reduced, MCI faces daunting challenges, not the least of which are pricing pressures in what remains a brutally competitive telecommunications industry.

MCI has already warned it expects revenues to drop 10 percent to 12 percent this year.

To offset the revenue decline, the company has taken steps to cut costs.

Last month, MCI announced plans to lay off 4,000 employees, reducing its work force to about 50,000.

"It's going to be a tough year," Mr. Capellas said. "But the good news about our industry is that people do communicate, and they communicate in more ways."

Mr. Capellas cited four areas where he saw growth potential for MCI: increased business from the company's current customers; global expansion; additions to MCI's array of products; and expansion of the company's security business.

"Even though there are certain areas in the industry that are compressing, we think there is some space to grow," he said.

In the course of the bankruptcy, MCI said it lost none of its top 100 customers. And in January the federal government, which collectively is MCI's biggest customer, lifted a six-month ban that had prohibited the company from bidding for new government contracts.

To a certain extent, MCI's growth prospects will be hampered by its bondholders, whose primary interest is to ensure they are repaid for their investment as soon as possible.

Even though many who contributed to the Worldcom scandal are gone, it will probably be some time before memories of what happened fade.

All of the senior executives and board members from the time when Bernard Ebbers was chief executive are no longer with the company.

Five executives, including Scott Sullivan, Worldcom's former chief financial officer, have pleaded guilty to federal charges for their roles in the scandal and are cooperating with the government in its investigation.

Mr. Ebbers has pleaded innocent to charges including conspiracy and securities fraud.

Bob Jensen's threads on Worldcom's accounting scandal, the biggest fraud in the history of accounting frauds, are at 

"Character to Be Major Issue in Tyco Trial," by Jonathan D. Glater, The New York Times, May 6, 2004 --- 

The trial of yet another former Tyco International executive begins today, and the outcome may well turn more on what jurors think about his character than on the facts.

The former chief counsel at Tyco, Mark A. Belnick, is charged with stealing money from Tyco in the form of unauthorized bonuses and loans, and with failing to disclose payments he received. In hearings, prosecutors have indicated that they hope to introduce evidence that they believe shows that Mr. Belnick has lied repeatedly — to get out of jury duty, to get a new driver’s license and to help his boss’s daughter get into business school, for example — to try to illustrate what kind of person he is. The judge has said that if Mr. Belnick testifies, prosecutors may question him about such past conduct, posing a problem for the defense.

Mr. Belnick’s case has transfixed the New York legal community because Mr. Belnick was a prominent lawyer at the top of the profession before joining Tyco in 1998. Mr. Belnick’s lawyers have argued that he has not committed a crime because he believed that the money he received was properly approved and disclosed, and that he did not know of any wider fraud at the company.

Whether Mr. Belnick has a history of telling falsehoods matters because to prove the charges against him, prosecutors must show that he knew he was doing something wrong. If jurors believe that Mr. Belnick is a chronic liar, it could be easier for prosecutors to convince them that he tried to conceal the money Tyco paid him.

On the other hand, if Mr. Belnick’s defense team succeeds in casting him as an ethical, straightforward lawyer who thought all his compensation and loans were properly approved by the appropriate executives and who was undone by a scheme outside his control and even his knowledge, then all the money he received from Tyco will not matter.

Mr. Belnick is the third former executive from Tyco to face a criminal trial. He is being tried separately from L. Dennis Kozlowski, the former chief executive, and Mark H. Swartz, the former chief financial officer, who have been accused of looting the company of hundreds of millions of dollars.

The issue of criminal intent also played a critical role in that trial. The jury’s deliberations foundered when one juror held out for acquittal, arguing that Mr. Kozlowski and Mr. Swartz did not believe that what they were doing was wrong. Their case ended in a mistrial last month after the holdout juror, identified by name in news articles during jury deliberations, said she received a letter pressuring her to convict the two men. (A spokeswoman for the Manhattan district attorney’s office said that Mr. Belnick was being tried separately because prosecutors did not charge him with participating in a criminal enterprise with Mr. Kozlowski and Mr. Swartz.)

As in the earlier case, some crucial facts in Mr. Belnick’s case are not in dispute. He did receive more than $14 million in relocation loans from Tyco. He did receive millions of dollars in bonuses and hundreds of thousands of Tyco shares, which he later sold for millions of dollars more.

So Mr. Belnick’s case could well turn on what jurors believe Mr. Belnick was thinking when he received some of the money. Mr. Belnick’s lawyers, in pretrial court documents, have argued that the loans at least seemed to be properly offered and approved, along with the bonus he received. No one on the defense team is saying whether Mr. Belnick will testify, or who might testify to his character.

Before joining Tyco, Mr. Belnick was a respected and accomplished lawyer at Paul, Weiss, Rifkind, Wharton & Garrison in New York. He was the protégé of Arthur Liman, a revered ney, told Justice Obus at the hearing. First, Ms. Schwartz said, according to records kept by Mr. Belnick’s accountant, Mr. Belnick did not become a Utah resident until the following year. Second, he did not file a Utah tax return in 2000, Ms. Schwartz continued, and third, she said, Mr. Belnick said in a sworn statement a week before the letter’s date that he lived in New York City.

Updates on Identity Theft

"Identity Theft, Fraud So Easy 'It's Absurd'," SmartPros, April 16, 2004 --- 

April 16, 2004 (Kennebec Journal) — KeyBank Maine President Kathyrn Underwood warned that the guest speaker's talk would leave the audience "scared to death," and she was right.

Over the next two hours, white-collar crime expert and former scammer Frank W. Abagnale told the 250 people at the Sable Oaks Marriott on Tuesday exactly how easy it is these days for criminals to steal their identities, forge their checks or otherwise defraud them. It's even easier today than when he was a globe-trotting flimflam man 40 years ago, Abagnale said.

"The fact is that what I did 40 years ago is 2,000 times easier to do today," he said.

Abagnale is the best-selling author of "Catch Me If You Can," and was portrayed by actor Leonardo DiCaprio in the recent hit movie by the same name. It's the story of how Abagnale cashed more than $2.5 million in bad checks in every state and 25 foreign countries between the ages of 16 and 21, impersonating an airline pilot, an attorney, a college professor and a pediatrician.

Police caught him when he was 21, and Abagnale served five years in prison. He was released on the condition that he would help the government by providing advice to law-enforcement agencies. Today, more than 14,000 businesses and law-enforcement agencies use Abagnale's services to prevent fraud.

He doesn't look much like DiCaprio, but his speaking voice has the cadence of a master salesman, giving a hint of the skills he used to fool bank tellers and police alike.

Abagnale described various types of white-collar crime, but spent a majority of the KeyBank talk focused on identity theft and check fraud. When Abagnale forged checks 40 years ago, he said, he needed a $1 million printing press. Today, $6,000 will buy highly portable, top-of-the-line computer equipment that can perfectly duplicate checks and other documents that don't have special defenses built into them, he said.

"Technology is only going to make crime easier -- always has, always will," said Abagnale.

In 2002, he said, there were 9.9 million victims of identity theft in the United States. Identity theft is when a criminal uses someone else's vital data (birth date, Social Security number and other information) to apply for such things as credit cards, home mortgages and car loans. Identity theft cost defrauded businesses $47.6 billion that year.

The total loss to individual victims was $5 billion, and they spent 297 million hours trying to resolve the tangled financial mess left by the thief.

Getting the information needed to steal an identity is "so simple it's absurd," said Abagnale. There are at least 22 different types of personal information that can be obtained off the Internet, Abagnale said.

There are Web sites that legally sell Social Security numbers. The Mormon Church keeps an online database of death statistics, and information such as birth date, date of death, Social Security number and last five addresses are included 10 days after someone dies, he said.

A scam artist can see in the newspaper that a wealthy stockbroker died, wait 10 days and get the information off the church Web site. He can use the information to apply for a credit card on a predated form, spend the money and leave the bill for the stockbroker's widow, said Abagnale.

"Everywhere we look, we're giving away information, every day, all the time," he said.

To protect against identity fraud, Abagnale suggested a service that he uses, . Anytime your credit is checked, said Abagnale, this company alerts you within 30 minutes.

"The only way to protect yourself against identity theft is to know when someone is doing it," he said.

April 19, 2004 reply from Robert Haun

I checked out the  and found 5 old credit cards that were on my report… thanks for the resource!


W. Robert Haun '01 
Alumni Information Systems Coordinator
Trinity University

April 21, 2004 reply from Lisa Austen [AUSTENL@MAIL.ECU.EDU

Oh my god, it just happened to me. I received a phone call this morning from someone telling me they were Citicorp Credit and that there was a problem with my AT&T Platinum Master Card and it would have to be cancelled and a new one issued. Being skeptical, I thanked the person for calling and said I would call the credit card directly. Turns out the Citicorp person was here's the latest scam. 

A florist in California tested my number with a $1 charge on Monday. Yesterday, a card with my number was used to purchase gas. Thank goodness, the credit card company was alert to this unusual activity. This is a card I never charge on, only make payments on because they gave me a good balance transfer rate last year. I just cut the card up and they'll be issuing another.


April 21 reply from David R. Fordham [fordhadr@JMU.EDU

I always find it interesting to learn how technology is being used (and

abused) in innovative ways. Get a load of this ATM scam, from the U-Texas Austin Police Department! Bob, have you seen one of these in your neighborhood?

David R. Fordham
PBGH Faculty Fellow
James Madison University

April 19, 2004 reply from Steve Curry 

My father lost several million dollars over his lifetime. In 1985, all our cars were repossessed. When he died last January, he was on a delinquent payment program with CitiBank. Yet he also died with five credit cards in his wallet, one $1600 over the limit and one $2000 over the limit. To this day, I still receive pre-approved credit card offers in his name – including offers from CitiBank even after I sent them a copy of his death certificate in order to terminate his existing account.

Something is terribly wrong. How can a dead man who should have a bad credit rating still be getting pre-approved for platinum credit cards? I’m sure “” does what it advertises but I am convinced that creditors are not checking credit histories in the first place. Either that or they are choosing to ignore what the reports tell them.

I suspect that marketer commissions are not linked to the validity or reliability of the credit being extended. I imagine that there is a wall of separation between the marketing division and the fraud division and it is easier to blame the other for the problem rather than working together to solve it. And I know that we consumers must bear our own share of the blame as we keep borrowing rather than following God’s commandment to “leave no debt outstanding” (Romans 13:8). (By the way, I’m studying for the ministry.)

In any case, it is apparent that when money is to be made, caution goes out the window. I fear it will take a disaster before people decided to follow the checks and balances they should have been following all along. And often, in the wake of such disasters, much effort is wasted in placing blame rather than rectifying the situation. Still, it seems that there would be some mechanism in place designed to prevent the problem from arising in the first place, especially in light of the current concern over national security and the funding of terrorism.

Steve Curry
Trinity University

April 19, 2004 reply from David R. Fordham [fordhadr@JMU.EDU

I agree.  So easy it is absurd.  Absolutely.  I’ve been pointing this out for a long time to the old-timers on this list.

And Bob, it isn’t just the Internet.  Your public library can reveal amazing things about you, too.  And even the government can help!  No kidding, hand on a stack of Bibles:  In the past 7 days alone, I have received two marriage licenses and six birth certificates (of LIVING people no less!), and have about ten more on order and presumably in the mail.  Total cost to me:  a set of checks totaling $84, written to entities such as Dupage County Illinois, Leon County Florida, Florence County South Carolina, Montgomery County Maryland, and State of Florida Department of Health. 

Forget the Mormon Church.  Your county’s courthouse Real Estate records office has on public display your old car loans, as well as home equity loans, and a lot of other loans besides your mortgage, and in many cases these documents include things like your bank account numbers (especially for direct deposit loans!), your escrow bank and escrow amounts, your mortgage account number, bank names and locations, etc. – I’ve even found where some lawyers include a copy of the loan application with the loan filing (about a tenth of the time, as an attachment), which includes annual income figures, credit card companies and account numbers, parents and children’s names and birthdates, social security numbers, etc.  IRA accounts, other assets, etc.   It is astounding what a dedicated researcher can find out about you.  And this is just the stuff available to the general public, too, and doesn’t include the stuff that so-called “authorized” officials can find out through Lexus-Nexus, the FBI, and other sources available to legal and law enforcement professionals!

Underwood was entirely correct.  If you were fooled into thinking there is such a thing as privacy, learning this will scare you big time.

But those of us who know what information is available enjoy hearty laughs whenever anyone complains about a “loss of privacy”!

I teach my students that only paranoid schizophrenics stay awake nights worrying about this.  Sure, a criminal can do you harm.  But a criminal can also mug you in the campus parking lot or break into your office.  You don’t do stupid things like walk in the parking lot at 3 am in the morning, or leave your checkbook lying on your desk while you go on vacation.  But at the same time, you don’t worry about what might happen by being in public, either.   I’m much more worried about a cell-phone-talking driver crossing the center line on the highway, or a thug stealing my ’95 Corolla or someone pickpocketing my wallet on the D.C. metro.  But I don’t lie awake worrying about that, either.   Fear-mongering is an age-old ploy used by the press to garner sales, and cancer scares are losing their impact, so the desperate reporters are exploiting the public’s ignorance about information availability.  And because of that ignorance, it’s working.  “Privacy Acts” and “privacy policies” are downright humorous.

Compare the number of your friends who have had their identities truly stolen to the number of your friends who have been in car accidents, contracted cancer, Alzheimer’s, Parkinson’s, had heart attacks, been sued, or any of a number of other bad-luck scenarios.   I’m not talking about third-hand I-know-someone-who-knows-someone-who-knew-someone, just compare your first-hand friends, to get an idea of the magnitude of the real problem.

One problem with the press’s pre-occupation with this type of fear-mongering is that paranoia tends to obscure rational decision making. 

And those who call for the removal of this information from public scrutiny are completely forgetting why that information is public to start with! 

Yes, I admit stealing an identity is so easy it is indeed absurd.  Absolutely.   But then again, if you’ll pardon me for being morbid, so is killing someone!   (And the latter tends to have much more permanent and uncorrectable consequences. And I’d dare say I could kill someone with a lot less effort than opening a credit card account in their name.  The only difference is in the amount of effort put into catching perpetrators and the penalties involved, which is an ENTIRELY different issue than (ridiculous) legislation being demanded to prevent the act from occurring.)

David R. Fordham
PBGH Faculty Fellow
James Madison University

April 21, 2004 reply from David R. Fordham [fordhadr@JMU.EDU]

The term "Identify Theft" is one of those terms whose misuse, misapplication, and abuse is quickly rendering the term meaningless as it becomes synonymous with "Fraud" and "theft of anything and everything under the sun".

This morning, I opened my morning mail and found an "Explanation of Benefits" from my health insurance company where they have paid $500 to a dentist who I never heard of. My name is listed as the patient, and the date of service is a date when I was traveling. As I write this, I am on "hold" on the phone listening to the insurance company's music, getting frustrated because I've already talked to four people at the company who say they can't help me -- even by taking a report! -- and I have to call another number, listen to some more music, punch some more touchtone keys, and wait some more. It's been 35 minutes since I first picked up the phone...

A colleague in the next office overheard my conversation and came over to co-miserate about "identity theft". It seems he had his wallet stolen, and someone used his credit card and this "Identity theft" cost him a lot of time. Identify theft. Yeah, right. Try "wallet theft" or "credit card theft" or "credit card fraud". But identify theft?

Well, I finally just got through to a person who sounded bored and who told me, "We'll take it off your claim history. We contacted the dentist office and they will get the information corrected and refile a new claim. The claim should have been for a lady."

What?! A new claim?! For a lady?! By a dentist I've never been to?

I asked if they were going to do anything else, and they said, "No, the lady at the dentist office assured us it was just a mistake and they would get it corrected. The new claim won't be under your name."

A mistake? How can a dentist office I've never been in file a claim (which makes it all the way to payment) with my name listed as patient? Where did the dentist get my filing information? Isn't anyone going to investigate that? "Nooooo. Too much trouble, and besides, they promised to correct it, so that makes everything ok."

And no, the insurance company won't tell me where the dentist is located so I can call myself, and find out where they got my name and filing information to file the original, um, "erroneous", claim!

Darn. If I weren't so ethical, I'd call a lawyer! ;-)

The insurance company personnel don't seem to care. -sigh- The "it's no skin off my back" syndrome seems to be kicking in... And to think I just wasted forty five minutes trying to help the company out.

Perhaps when Bonnie and Clyde had robbed the bank, when the sheriff came to arrest them, they should have said, "Sorry, it was just a mistake, we'll get it corrected!" and all would be well.

My explanation of benefits says "Amount You Owe To the Above Dental Care Provider" is $330. I really hope the dentist office sends me a bill for that!

Identify theft? Sheeesh...

Sign me: "Frustrated, cynical, disgruntled, -- but with really good teeth..."

David R. Fordham
PBGH Faculty Fellow
James Madison University

Even Porn Addicts Are Suddenly Afraid To Go To Porn Sites (although you can get hit from elsewhere)!
Known as bot software, the remote attack tools can seek out and place themselves on vulnerable computers, then run silently in the background, letting an attacker send commands to the system while its owner works away, oblivious. The latest versions of the software created by the security underground let attackers control compromised computers through chat servers and peer-to-peer networks, command the software to attack other computers and steal information from infected systems.
Robert Lemos , CNET, April 30, 2004 --- 
For more on bot software and spyware, go to 

"What's That Sneaking Into Your Computer?" by David Bank, The Wall Street Journal, April 26, 2004

New types of insidious programs called "spyware" are burrowing into PCs, wreaking all sorts of problems. These small programs that install themselves on computers to serve up advertising, monitor Web surfing and other computer activities, and carry out other orders are quickly replacing spam as the online annoyance computer users most complain about. Here's what's being done to combat them.

John Gosbee was sitting up in bed on a cold night, surfing the Internet with his laptop on his knees. Suddenly, the computer's CD-ROM tray popped open, seemingly on its own.

"What on earth is going on?" Mr. Gosbee, of Mandan, N.D., said to himself. "It was like it was possessed," he recalls.

His laptop emitted a high-pitched "Uh-oh."

Uh-oh is right. The pranks were a setup for the message that appeared on his screen: "Dangerous computer programs can control your computer hardware if you fail to protect your computer right at this moment!" That was followed by a plug for a program called Spy-Wiper that promised to clean out any rogue software.

As if that wasn't alarming and annoying enough, the very next day the computer at Mr. Gosbee's one-man law office was similarly hijacked. The CD and DVD trays both opened; only one closed. Then came the same ad for Spy-Wiper, which kept popping up on both machines.

"I was getting ticked," Mr. Gosbee says.

As Mr. Gosbee and countless other computer users have discovered: It's a war out there. While malicious hackers are spreading viruses all over the global computer network, advertisers and scam artists are propagating other pests that are arguably even more annoying. They're called spyware -- and the implications for consumers are only beginning to be felt.

Indeed, spyware -- small programs that install themselves on computers to serve up advertising, monitor Web surfing and other computer activities, and carry out other orders -- is quickly replacing spam as the online annoyance computer users most com- plain about. The outrage has grown to the point that politicians are threatening legislative controls on the tactic. But in their most benign form these programs have a powerful appeal to advertisers, and some marketers are banking on the idea that people eventually will grow accustomed to some use of such invasive software.

"Snoops and spies are really trying to set up base camp in millions of computers across the country," said Sen. Ron Wyden, an Oregon Democrat, at a March hearing on proposed legislation he is co-sponsoring to tackle the problem. A Republican co-sponsor, Sen. Conrad Burns of Montana, said at the hearing: "I'm convinced that spyware is potentially an even greater concern than junk e-mail, given its invasive nature."

Continued in the article

Bob Jensen's threads on security are at 

From The Wall Street Journal Accounting Educators' Review on May 14, 2004

TITLE: Yahoo, Google and Internet Math 
REPORTERS: Scott Thurm and Kevin J. Delaney 
DATE: May 10, 2004 
TOPICS: Earnings Quality, Financial Analysis, Financial Statement Analysis, Internet, Revenue Recognition, Accounting

SUMMARY: Differences in accounting at Yahoo Inc. and Google Inc. make it difficult to compare the financial performance of the two companies. Questions focus on revenue and expense recognition principles.

1.) What is revenue? What is an expense? Describe the revenue recognition and matching principles.

2.) Explain the primary and secondary qualities of decision usefulness. What property (or properties) of decision usefulness is (are) being compromised by different accounting methods at Yahoo and Google?

3.) Explain the different accounting methods being used for revenue and expense recognition at Yahoo and Google. What differences result in the financial statements?

4.) Explain the difference between recognizing revenue at the gross amount and recognizing revenue at the net amount. Using authoritative guidance, explain when each method is appropriate.

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

"Yahoo, Google and Internet Math," by Scott Thurm and Kevin J. Delaney, The Wall Street Journal, May 10, 2004, Page C1 ---,,SB108415195909406432,00.html 

Revenue Is Counted Differently By the Web-Search Powerhouses, Creating Confusion for Investors

Yahoo Inc. reported first-quarter revenue of $758 million. Looked at another way, Yahoo said revenue totaled $550 million. Rival Google Inc. said its first-quarter revenue totaled $390 million. Or maybe it was really $652 million.

Confused? Pity the investors trying to place a value on Google for its highly anticipated initial public stock offering.

For guidance, many look at Yahoo, another Internet company with a similar business to Google's and which has been public since 1996. But Yahoo and Google don't count revenue the same way, making it hard to compare many aspects of the two companies' finances. Google uses a more-conservative definition that has the effect of damping its revenue and increasing its profit margins.

The differences demonstrate that accounting standards may be "generally accepted," but they aren't always uniformly interpreted. And details about revenue-recognition policies buried in the fine print of financial statements can trip up less-than-seasoned investors.

In this case, the difference revolves around the way that Yahoo and Google treat revenue from small-text advertisements that they place on other companies' Web sites. The two Internet companies effectively act as technological intermediaries and quasi-advertising agencies, bringing together Web publishers and advertisers. Yahoo and Google get paid each time an Internet user clicks on an ad, then give some of that money to the Web publisher on whose site the ad appeared. (Yahoo and Google also accept ads for their own sites, and both companies account for them in the same way.)

In accounting terms, however, that is where the similarities end. Yahoo counts as revenue the "gross" amount it is paid. It counts its payment to the publisher as an expense, labeled as a "traffic acquisition cost." Google, by contrast, counts as revenue only the "net" amount remaining, after it pays the Web publisher.

Here's how it works in practice: XYZ Corp. places ads on the sites of UVW Corp., through Yahoo, and RST Corp., through Google. Both ads generate $5 in revenue, with $3 going to the publishers. Yahoo would count $5 revenue and book a $3 expense. But Google would record only $2 in revenue.

Experts say the difference shows how accounting practices are still evolving in relatively new forms of commerce such as the Internet. There isn't a universal right answer, they say; the proper accounting depends on the specifics of the advertising contracts.

"Financial reporting in this area is fluid right now," says Paul R. Brown, an accounting professor at New York University's Stern School of Business.

Indeed, until Jan. 1, the same distinction between "gross" and "net" revenue could be seen within two units of InterActiveCorp, the New York-based Internet company.

InterActiveCorp's Expedia travel-agency unit reports revenue on a "net" basis, after paying airlines and hotels. But InterActiveCorp's unit traditionally reported revenue on a gross basis, recording the entire price of a hotel room, including the portion it paid to the hotel operator. switched to reporting net revenue beginning this year, according to a filing with the Securities and Exchange Commission.

In the case of Yahoo and Google, the proper accounting treatment depends on whether the company is merely an "agent" facilitating a deal, or a "principal" that stands to lose money, if, for example, an advertiser fails to pay.

A Yahoo spokeswoman says the company reports gross revenue "based on our interpretation of the accounting guidance and our contractual terms." In SEC filings, Yahoo says it must use gross revenue because it is "the primary obligor" to the publishers.

Although it uses "gross" revenue in its financial reporting, Yahoo stresses its "net" revenue in presentations to analysts and investors. The spokeswoman says Yahoo considers the net figure "of more transparent economic value to investors."

Analysts generally agree. "We actually take a net revenue perspective on their numbers," says Jeetil Patel of Deutsche Bank Securities Inc. Mr. Patel says using net revenue makes it easier to understand Yahoo's different businesses and compare current with past results.

Continued in the article

Bob Jensen's threads on revenue accounting are at 

Automobile Financing and Cheating
I have a Web document on automobile financial fraud and dirty tricks at

May 6, 2004 message from Mike Gasior [


By Mike Gasior

It is my habit to read an amazing number of periodicals in the course of any given month and this has been a fairly standard practice for me for the better part of the past 25 years. Whether it's newspapers, magazines, catalogs or now the near bottomless pit of information available via the Internet, it has always proven fascinating to me all the amazing things that seem to happen in the world during any given day. This is what makes it so difficult for me to decide what stories and situations I feel like expanding upon in this monthly tirade of mine. Sometimes I cannot help but discuss one of the major news stories because there is usually a reason they are considered major. More often, I enjoy focusing on stories somewhat off the beaten path that I think are important and deserving of more attention.

This will be the case this month. There are two stories I found important and not getting much mainstream media attention and wanted to focus more attention to. The third subject I decided to address is just plain interesting to me. The topic of my video commentary will be the scary situation the U.S. Treasury has put the United States in with the changes in how they've been borrowing money over the past seven years or so. With even the slightest rise in interest rates, we could see an enormous hole blown into the U.S. Federal Budget. You can view the video commentary by visiting the homepage at:

Now onto the topics of the month.


For those of you who only faintly remember the name "Executive Life", they were a spectacular corporate failure long before there ever was a WorldCom and prior to you ever hearing about a company named Enron. Executive Life was a terrifically successful life insurance company headquartered out in California and rose to an amazing stature during those roaring 1980's. They offered a host of innovative insurance products as well as outstanding returns for their policyholders. Perhaps the most impressive was the fabulous ratings from Moody's and S&P (Aaa & AAA respectively) that gave Executive Life a very special aura when compared to larger, older and staid life insurance companies. Executive Life was the new breed of insurance company and viewed as the model for the future. That was the case, of course, until they came tumbling down into insolvency.

You see, the way Executive Life was able to offer these outstanding returns was in savvy investments in the Junk Bond market. The guy running things at the time was a guy by the name of Frederick Carr who had a friendly and tight relationship with none other than Michael Milken himself. The trouble began in 1991 when a crash in the Junk Bond market caused Executive Life's portfolio to tumble, and ultimately they ended up in receivership. As an interesting side note, they wore their AAA/Aaa ratings right into bankruptcy court, but that is the subject for a whole other newsletter.

Now the insurance commissioner in the State of California wanted the policy holders of the failed company to be compensated to the fullest extent possible and the insurance company and the assets they held were put up for sale to the highest bidder. There were many interested parties to this auction, but none more interested than the highest bidder, the French bank, Credit Lyonnais, which at the time was owned by the French government. Credit Lyonnais thought the bond portfolio of Executive Life might actually recover nicely and there was potentially a wonderful windfall in store for whoever ended up with the Executive Life inventory of Junk Bonds. The only problem was, there were a variety of laws that prevented Credit Lyonnais from owning a company like Executive Life.

For one, the Glass-Steagall Act was still in effect back in 1991, and it barred banks from owning certain non-bank entities like Executive Life. Plus, there were California State laws that prevent banks owned by foreign governments from owning California insurance companies. But Credit Lyonnais was not going to be deterred that easily, even though violating these laws could result in criminal prosecution, stiff fines and being thrown out of the U.S. banking market by the Federal Reserve.

To disguise who was actually purchasing Executive Life and their bond portfolio, Credit Lyonnais put together a group of French investors to be face for the purchase, particularly French billionaire Francois Pinault who owns Gucci, the Christie's auction house and the huge French retailer Printemps. Credit Lyonnais and the partners crafted a secret deal where the partners would make the purchase, but where Credit Lyonnais was the true buyer. Ultimately Credit Lyonnais would sell the insurance company and some of the bond portfolio to Mr. Pinault as his reward for being the public face of the transaction.

To make a relatively long story a lot shorter, the bond portfolio DID rebound and the purchasers enjoyed a profit of just over $2.5 billion. Unfortunately, however, for Credit Lyonnais and Mr. Pinault there was someone intimate to all the secret agreements and deals who decided to become a whistle blower to the U.S. Government and to the State of California. The identity of the whistle blower is still secret and may never be known.

Needless to say, these revelations were quite bothersome to the U.S. Attorney's office in Los Angeles, as well as the State of California Insurance Commissioner. As you might expect, indictments were prepared to bring charges against all the participants for their illegal behavior. As you might ALSO expect, the French government thought the entire matter was trivial and would ultimately be swept under the rug through diplomatic and political channels. Although there were numerous meetings and discussions between the Bush and Chirac administrations, it seems the Bush crew was not a sympathetic audience and the decision was made to let the Los Angeles prosecutors pursue their case without any interference or comments whatsoever. Even still, the French government refused to believe that any of these charges were particularly serious, nor were they concerned that this case would result in anything more than a slap on the wrist for anyone involved.

Unfortunately for everyone involved, the prosecutors thought the charges were extremely grave, and obtained secret indictments against the French government, Credit Lyonnais, Mr. Pinault, and an assortment of French bankers during July of 2003. Finally, the negotiations began in earnest to reach a plea bargain that would assure that no one would serve time in jail, and to bring these matters to a close.

This criminal case of fraud ultimately was settled recently with:

--A guilty plea to criminal fraud by the French government and others involved.

--A total of $770 million dollars in fines, which is the largest criminal settlement in U.S. history. The fine broke down as follows:

*$375 million paid by the French government.
*$200 million paid by Credit Lyonnais.
*$185 million paid by Mr. Francois Pinault.
*$10 million paid by MAAF (A French insurance company who fronted the transaction)

Suffice it to say, this was all fairly bad news for the whole sorry crew, but things might actually be getting much worse for them. It seems the California Insurance Commissioner's Office is still feeling like they've been robbed and have filed a massive civil suit seeking about $5 billion from the participants including about $2 billion from Mr. Pinault himself. Obviously, if a jury comes back with a punishing verdict, this may lead to a fire sale at Gucci, Christies and other places as Mr. Pinault is asked to produce a sizable check. One must also figure this whole situation is probably also serving to sour (even further if that's possible) the relationship between the U.S. and French governments.

As much as you might think I'm just sticking it to the French once again, you have to admit that the story is intriguing and a bit intoxicating. After all, how often is a sovereign government ever found guilty of criminal behavior of any kind. Much less, the accuser and the accused both being members of the G7. And yes..I know it's now officially the G8, but Russia has a lot of work ahead of them before they belong (economically) in the category of the other seven countries, but there is yet ANOTHER newsletter topic.

Now we can wait and see how much uglier this situation may become. One thing is always true with me; if two guys want to fight, I am ALWAYS happy to hold their jackets for them.

An elaborate game created last year by the McCombs School of Business at the University of Texas at Austin teaches students about handling the delicate balance of business and ethics, and the sometimes high moral price of too much cost cutting.

"A Delicate Balance," by Scott McCartney, The Wall Street Journal, May 10, 2004, Page R7 ---,,SB108379356955403126,00.html?mod=gadgets%5Fprimary%5Fhs%5Flt 

For one business-school class, a simulation game provided
a painful lesson in the price of obsessive cost cutting

For the young executives at computer-maker InfoMaster Ltd., the company budget was on the line. Terrorism threats were swirling in Jakarta, Indonesia, and the company had to either shut down production there for one quarter and harden security or keep churning out hot-selling products.

The executives opted for production over protection. Soon after, a bomb exploded at the plant.

"I just killed 350 people," said a dazed David Marye, InfoMaster's 25-year-old chief ethics officer. "I made a bad call, and people died. It's going to be hard to sleep tonight."

Luckily for Mr. Marye, both InfoMaster and the terrorist attack were fictitious, part of an elaborate game created last year by the University of Texas at Austin's McCombs School of Business. Three made-up student-run companies competed in the cutthroat computer-hardware industry, all trying to maximize revenue, keep costs down and beat back competitors. But the prizes -- $11,000 and the chance to perform in front of a high-level, real-world executive panel -- were real.

While the Sim City for the business world appeared to be about the bottom line, the real intent was to teach students about handling the delicate balance of business and ethics, and the sometimes high moral price of too much cost cutting. The results were eye opening -- and painful. Idealistic students, who started the game preaching virtue, succumbed to the everyday challenges of making their numbers and whipping the competition. Buying cheaper components or hiring cheaper workers would allow more production. Not spending resources on training or quality control would let them get new products to markets faster, but there might be a price to pay down the road. The game proved so realistic that some students were stunned that, under pressure, they readily chose corner-cutting paths they had vowed never to take.

The Texas program was created after the WorldCom scandal broke, as officials looked for ways to teach better behavior to M.B.A. students. The academics knew that while students talk like angels in ethics classes, they behave avariciously in finance classes. "Ethical issues aren't being addressed in financing, marketing and accounting classes," says Steve Salbu, the associate dean for graduate programs and founder of the school's business-ethics program. "We needed to try to do something we think might be effective."

Applying Pressure

Steven Tomlinson, a finance lecturer who has a background in theater, pushed to put students under pressure and throw choices at them. He hired Allen Varney, an Austin-based designer of video and board games, and consulted with a soap-opera scriptwriter and corporate executives. Scripts were written, rules devised and software created to track decisions.

The result was the Executive Challenge, a three-day game played late last year, where teams of about two dozen students were divided into three companies, with each given a limited amount of production capacity and a set of workers with varying skills. A company could borrow money, and it could spend cash to increase capacity or add products or workers. But it also had to take care of existing projects and decide whether to spend precious resources on corporate-culture projects such as diversity training and quality programs.

A three-month financial quarter typically lasted 30 minutes, forcing companies to communicate and make decisions in rapid-fire fashion. The game offered both individual and corporate shortcuts and lures. Early on, players might get away with ignoring problems and postponing expenses, but then the problems grew like weeds. A team could opt for lower quality for a quarter or two, only to discover later that its computer batteries exploded -- a scenario taken from Dell Inc.'s history.

"The game is all about temptation," Mr. Varney says. "Business-school students, as a breed, are overconfident, and the game really plays to that."

Going in, students suspected that the game would likely test their ethics since they had just come off a week of traditional ethics training. On the first day, all three made-up companies -- InfoMaster, General Data Machines Inc. and Starr Computing Co. -- spent money on corporate-culture initiatives at the expense of new products, surprising Mr. Varney, the game designer. "All those goody-goodies are doing the corporate-culture initiatives," he said, "which makes no sense in dollars and cents."

Textbook Traits

Indeed, the teams created their companies around textbook traits like collaborative decision making and promises to share prize money equally. Fearful of repercussions, executives decided to pay themselves little if any salary. "They were remarkably socialistic," Dr. Tomlinson says.

InfoMaster even created an ethics team with leaders from different departments, headed by Mr. Marye, who worked as an analyst for Houston-based Enron Corp. before seeking a master's degree.

Yet as the revenue race tightened, behavior changed. On the second day, each company learned that it had hired an employee who had stolen software from a competitor and that the stolen code was now used in the company's highest-margin products. General Data and Starr both opted to turn themselves in and try to negotiate licenses. InfoMaster, despite its ethics team, took the path of least resistance, hoping not to get caught.

General Data proved consistent with its choices -- for the most part. Faced with a toxic-waste issue at a river near one of its plants, it opted to dredge the river and make the issue public, even though it didn't believe it was responsible for the pollution. But doing the right thing came at a price. The company was in last place in revenue after the first day.

"Ben and Jerry would not do well at this game," Mr. Varney says, referring to the socially concerned ice-cream entrepreneurs.

Much as the game's creators expected, student executives began routinely opting for less-expensive options by the end of the second day. General Data was hit with a sexual-harassment complaint against its vice president of sales, and it chose to postpone action while investigating the allegation. At the time, the company was short of cash and was trying to aggressively ramp up product development to catch competitors. Besides, a previous complaint had turned out to be unfounded.

This time, though, the investigation discovered that the complaint was credible, and major. "We thought we did the right thing," said Jay Manickam, a former consultant for Andersen and Deloitte & Touche who was General Data's chief executive. "But this is apparently going to be a hit."

Continued in the article

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Professor Robert E. Jensen (Bob)
Jesse H. Jones Distinguished Professor of Business Administration
Trinity University, San Antonio, TX 78212-7200
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