Accounting Scandal Updates on August 20, 2002
Bob Jensen at Trinity University

Bob Jensen's main document on the Enron scandal and other accounting frauds is at 

Sharing Professor of the Week  (Education, Teaching, Case Method, Enron)
Not all of Professor Bruner's online materials are are free, but he does have some free Website materials at 
I have also ordered some of his materials that can be purchased, because they really look interesting.

Some great materials (cases, papers, etc.) from one of the finest finance professors in the world are available online (for a fee).  I discovered these in the August 13, 2002 interview with Robert Bruner in a newsletter called FinanceProfessor News.  Sign up for the Free newsletter! Indeed have your classes do so as well. It is free and your name and address will never be given out or sold. 


Abstract: Socrates’ Muse:

Case: Enron 1986-2001

Case: Enron’s Weather Derivatives

Note to the Student: How to Study and Discuss Cases;

Essay: “Opening a Course:”

Essay: “Setting expectations”:

Case Studies in Finance, Fourth Edition

A complete listing for Robert Bruner on SSRN:

Educator: Courses, Cases and Teaching --- 
Editors: Robert F. Bruner and Peter Tufano and Kent Womack
Darden Graduate School of Business Administration, University of Virginia and Harvard Business School and Dartmouth College

Major New Law in the Wake of the Accounting and Finance Scandals
Provisions that include the following:

Most items of the original Sarbanes bill prior to the House and Senate Conference Committee revisions remain intact.  For a helpful summary, see 

A detailed summary of the Act can be downloaded from 

Hi Dan,

A detailed summary of the SO Act (which might better be termed the SOS Act) can be downloaded from 

Bob Jensen's current threads on the act can be found at 

Two points made in the AAA meetings in San Antonio are that the jail time increase is largely a sham. There are no new funds at the Justice Department to enforce the new law, and there were few serious convictions in the past when the penalties were more limited. It is not likely that the threat of added jail time have deterred the executives recently arrested.

A second point is that the five-year rotation provision is very burdensome on small client audits. The example given by Robert Herdman is the case where a senior manager on a small audit is normally in line to become the audit manager. Having said this, I think the idea of rotation of lead partners is a very good idea.

There are many other provisions that have yet to be sorted out. I personally think the task of the oversight board (that I previously called the Lone Rangers when Harvey Pitt exposed the idea) is too overwhelming to be effective and efficient. What I truly hope is that the board restores substantive testing as a more serious component of auditing. Substantive testing may not be very effective in uncovering fraud, but the threat of serious substantive testing is an effective deterrent in many instances. There are rumors that substantive testing was steadily on the decline in Andersen audits. The extent to which this is a fact remains a research question.

What disappointed me in the SO Act is the failure to encourage and reward more whistle blowing. Therein lies the real power of keeping the system honest in a litigious society like the U.S.

What does seem to be working is the fear, among virtually all executives, that the future of equity markets is at stake unless the system is repaired in reality to a point where investors regain confidence in equity investments. Big corporations are now viewed as more criminal than the Mafia, because some CEOs make more money than Mafia leaders and have more power.

If you missed Bill Kinney's presentation in Plenary Session 3 in San Antonio, you missed one of the most powerful and tearful presentations on the distorted power of top management over Boards of Directors, Audit Committees, Auditors, Analysts, and government officials in the federal and state legislatures. I hope to make Bill's PowerPoint slides available at my Website in the future (I only wish I could capture his tear stains on each slide).

Too many of our corporate watchdogs have become CEO pet rocks.

Bob Jensen

-----Original Message----- 
From: Dan Stone [mailto:dstone@UKY.EDU]  
Sent: Tuesday, August 20, 2002 9:37 AM 
Subject: HR3763

I’m preparing to teach classes in accounting consulting & graduate accounting systems this year. I’m wondering if anyone has seen or created teaching materials related to HR3763 – the corporate & accounting reform bill (often called, “the Sarbanes-Oxley Act of 2002”). Obviously, there is much here that is relevant to our students.

I found some information at the following sites:

Law firm website: 



Bob Jensen's summary of other proposed reforms can be found at 

From the The Wall Street Journal Accounting Educators' Review on August 1, 2002

TITLE: Corporate-Oversight Bill Passes, Eases Path for Investor Lawsuits 
REPORTER: Richard B. Schmitt, Michael Schroeder and Shailagh Murray 
DATE: Jul 26, 2002 
TOPICS: Accounting, Audit Quality, Auditing, Code of Ethics, Consulting, Corporate Governance, Financial Accounting Standards Board, Regulation, Securities and Exchange Commission, Shareholder Class-Action Lawsuit, Standard Setting

SUMMARY: In response to a growing number of fraudulent financial reporting cases, Congress approved legislation with significant implications for the accounting profession. Questions focus on the nature of the changes and the future of accounting.

1.) Describe the major changes in the legislation passed by Congress. Briefly discuss positive and negative implications of each of the components of the legislation.

2.) Why was there a need for the changes included in the legislation? Compare financial reporting in 2001 to financial reporting in 1929. What changes were made in the early 30s in response to financial reporting in the late 20s? How do the changes of the early 30s compare to the legislation passed by Congress in 2002?

3.) Which of these changes will have the greatest impact on the accounting profession? Discuss how this change will affect the accounting profession in the future.

4.) What is a class-action lawsuit? Describe President Bush's position on class-action lawsuits. Is the legislation passed by Congress consistent with this position?

5.) How do you think that the increased threat of litigation will change the quantity and quality of accounting majors? What changes to accounting education are needed to prepare students for the future business environment?

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

TITLE: Governance Bill Has Major Consequences for Many 
REPORTER: Shailagh Murray and Michael Schroeder 
ISSUE: Jul 26, 2002 

~ + ~ + ~ + ~ + ~ + ~ + ~ + ~ + ~ + ~ + ~ + ~ + ~ + ~ + ~ + ~ + ~ + ~ + ~ + ~ +

TITLE: Dock Workers, Operators Agree To Suspend Their Contract Talks 
REPORTER: Daniel Machalaba and Queena Sook Kim 
DATE: Jul 29, 2002 
TOPICS: Information Technology, Managerial Accounting, Productivity

SUMMARY: Machalaba and Kim continue their reports on the state of contract negotiations between the unions and management on the West Coast docks. The issues remain the same: jobs versus technological innovation. The terminal operators and union representatives have agreed only to suspend talks aimed at reaching a new labor agreement.

1.) What is the theory of constraints? What is the principle bottleneck in the two West Coast docks? How does the Pacific Maritime Association go about dealing with this constraining factor?

2.) If the capacity of this constrained factor should increase, what effects would it have on shippers? Wholesalers? Retailers? Consumers? Union workers?

3.) Re-read the related article. What would happen to the productivity measure discussed in that article should the status quo be maintained? Would it stay the same? As a practical matter, what can the customers of the docks do to mitigate the problems of the constrained facility? Whether the docks are updated with new technology or not, what is the long-range effect on the number of union jobs at those docks?

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

TITLE: West Coast Docks Face a Duel With Union About Technology 
REPORTERS: Daniel Machalaba and Queena Sook Kim 
ISSUE: May 12, 2002 


AICPA News Alert

Dear Fellow CPA: 

This is a time of unprecedented change for the CPA profession. Scrutinized on Capitol Hill and under attack from the media following Enron, WorldCom and other high profile business failures, our profession’s self-regulation and sacred trust have been called into question.   In the wake of this turbulent environment, President Bush signed into law on July 30, 2002, the most significant legislation affecting the accounting profession since 1933-- the Sarbanes-Oxley Act of 2002. 

This new legislation brings uncharted waters for the CPA profession, particularly in the areas of standard setting and quality review.  The AICPA has been studying these changes and is here to provide you with the information you need to navigate this complex situation.  This e-mail highlights both our efforts during the past months and provides several items: (1) a summary of the new legislation, (2) a list of the provisions that will most affect the accounting profession, and (3) an overview of resources to help you understand the legislation and its impact on the profession.  You will continue to receive similar updates in the months ahead.

One of the resources we have created to help members work through the legislation is a toll-free number.  Members who have questions about the new law and how it will impact their firm or company, should call 866-265-1977.  The hotline will be staffed Monday through Friday for the remainder of 2002.  More details, as well as a list of other resources, are available later in this e-mail.

As we move forward to address these developing issues, let us be clear. We are determined to restore the public’s faith, and the faith of our members, in the honorable credential of CPA.  Our
profession’s core values always have been and will be: integrity, competence, and objectivity.  As the vision statement that grew out of the grassroots efforts of CPAs across the nation asserts, CPAs are the trusted professionals who enable people and organizations to shape their future.

Hundreds of thousands of CPAs serve the public interest each and every day.  We cannot allow a handful of CPAs and the fierce search for blame to taint the 340,000 CPAs in this country who stand by our values and make hard, ethical decisions without hesitation.

Unfortunately, the media, political and legislative fervor have frequently drowned out our simple and unshakeable message: This profession and its professional association cannot and will not tolerate any member in corporate America who seeks to commit fraud.  Nor will we tolerate any AICPA member who performs substandard work and veers away from the fundamental code of ethics and responsibilities that have defined the CPA profession for over a hundred years.  These are values we have labored long and hard to communicate to the press, to the public and to our membership.

We have walked a difficult road these past few months, determined to do the right thing by the public and by the honorable men and women in this profession.  Developing meaningful reforms that protect the public interest and restore confidence in the accounting profession has been our primary focus. Thousands of volunteer and staff hours have been committed to educating and testifying before Congress, working with the media, analyzing the issues and identifying new reforms. In the end, the new legislation recently signed by President Bush does reflect our influence in measures that distinguish between auditors of publicly traded companies and those of private entities.

The Sarbanes-Oxley Act of 2002

The Sarbanes-Oxley Act of 2002 dramatically affects the accounting profession and impacts not just the largest accounting firms, but any CPA actively working as an auditor of, or for, a publicly traded company or any CPA working in the financial management area of a public company.

Essentially, the Act creates the five-member Public Company Accounting Oversight Board (PCAOB), which has the authority to set and enforce auditing, attestation, quality control, and ethics (including independence) standards for public companies.  It is also empowered to inspect the auditing operations of public accounting firms that audit public companies as well as impose disciplinary and remedial sanctions for violations of the board’s rules, securities laws and professional auditing standards.

Other provisions affecting the profession include requiring the rotation of the lead audit partner and reviewing audit partner every five years and extending
the statute of limitations for the discovery of fraud to two years from the date of discovery and five years after the act (previously one year and three, respectively). The bill restricts the consulting work public company auditors can perform for their public audit clients and establishes harsh penalties for securities law violations, corporate fraud and document shredding.  To read a detailed description of the Sarbanes-Oxley Act, go to

The ramifications of some of the provisions in the Sarbanes-Oxley Act will become known only as the SEC and the new Public Company Accounting Oversight Board begin implementing the bill.  We will continue to analyze the legislation and keep you informed of how it will impact the profession.  These are the areas you should be aware of:

 AICPA Support for Meaningful Reform

There is no question that the provisions of the Sarbanes-Oxley Act are challenging.  Shortly after Enron’s collapse, we realized that the public who relies on the services of public company auditors no longer accepted our system of self-regulation and that we needed to take the lead in pursuing significant reform.  We called for meaningful changes to strengthen the capital market system and increase public confidence.  We advocated—



Our calls were ultimately heard by Congress and many of our goals are reflected in the final Sarbanes-Oxley Act. 

But it will take more than legislation to restore investor confidence in the capital markets and in the audit function.  We continue to encourage the FASB to address the meaningfulness of the financial reporting model and the related disclosures.  Also, fundamental changes are forthcoming to the audit risk model currently under consideration by the AICPA’s Auditing Standards Board.  In the near term, we expect the Auditing Standards Board to issue a new standard on fraud, which will significantly enhance the auditor’s procedures and processes to detect material fraud in financial statements.

Your Professional Resource

To help you understand the ramifications of the Sarbanes-Oxley Act of 2002, the AICPA is developing several resources.  A new toll-free number is available for any questions your firm or company may have about the legislation, how it will be implemented and how to comply.  The hotline will be staffed Monday through Friday for the remainder of 2002. Call 866-265-1977 and select the option that is most appropriate for your firm or company.  You will receive a response within twenty-four hours.

In addition, the AICPA will be creating periodic Webcasts to brief members on issues as they emerge, as well as short video clips and news alerts that will be sent to members through e-mail.  To change your e-mail address, please call Member Satisfaction at 888-777-7077 or e-mail

Firm leaders also are encouraged to attend “A Profession in Crisis…Preparing Today for Tomorrow,” scheduled for November 11-13 in Phoenix, Arizona.  This symposium, developed by the AICPA MAP Committee, will discuss the reforms on Capitol Hill, the latest developments in the profession, perspectives from government and legislative leaders, as well as provide a forum for questions in an interactive Town Hall.  Event highlights include an address by David M. Walker, Comptroller General of the United States, and a dialogue with Joseph Berardino, former CEO of Arthur Andersen.  For more information or to register, please visit or call toll free 888-777-7077/direct 201-938-3000.  PCPS member firms can also find information at

We are also working to determine the appropriate role of the SEC Practice Section within the framework of the new oversight board and to work with the SEC to establish an orderly transition of SEC Practice Section activities.  Additional regulations will be forthcoming from the SEC and the PCAOB.  We will keep you informed as this process moves forward.  In the meantime, all of our standard setting work will continue.  There is important work that needs to be done and it is in the best interest of the public and the profession to keep those activities moving forward during this new era.

Our Council and Board of Directors have been our unwavering guide during the past months.  With representatives from every segment of the profession-- seven from small firms; four from medium firms and two from large firms; four from business and industry; one each from government and education; and three public members-- the Board continues to be your voice, sharing your thoughts and concerns.

As the national professional home for CPAs, we share your deep concern over this situation and its effect on our business communities and profession. Rest assured that the AICPA will continue to be on the frontlines in the media and on Capitol Hill, sharing the profession’s core values and the unwavering ethical commitment for which CPAs have always been known.  We are dedicated to restoring the public confidence in the CPA as America’s most trusted financial advisor and guardian of the public interest.

Yours sincerely,

James G. Castellano, CPA
Chair of the Board

Barry C. Melancon, CPA
President and CEO

Visit for more information on federal and state legislation, the profession’s response, exposure drafts, communications to members, financial reporting and other related issues.

To share your comments, please send an e-mail to

To opt out or opt in to all AICPA electronic mailings, please send an e-mail with your membership number to

"Merrill Defends Enron Research But Analyst Says Pressure Existed,"
Charles Gasparino and Randall Smith, Wall Street Journal, July 31, 2002

During more than two decades as a stock-research analyst, many of them covering big energy companies, John Olson has spoken with many top executives. But none of those conversations stood out like the one he had with Kenneth Lay. In the late 1990s Mr. Lay, the Enron Corp. chief executive, was unhappy that Mr. Olson, then at Merrill Lynch & Co., had placed a "neutral" rating on Enron stock, and wanted him to upgrade his call, the analyst says. Mr. Olson says in an interview that Mr. Lay told him he "just didn't get it."

But Mr. Olson, now 60 years old, says he wouldn't budge. So Mr. Lay complained to Merrill investment bankers who at the time were denied Enron investment-banking business and the lucrative underwriting fees they produced. "We are for our friends," Mr. Olson says Mr. Lay told him. It was only after Mr. Olson left Merrill under pressure in August 1998 that Merrill eventually did win tens of millions of dollars in Enron banking business and upgrade the company's stock to an "accumulate." It is "very, very clear why I left Merrill," says Mr. Olson, now at Sanders Morris Harris, a small Houston securities firm. "There was a clear preference for positive recommendations regarding Enron, and I wasn't going to give them that."

A Merrill spokesman vigorously denies that Mr. Olson was forced out because of his negative calls. "We had a consolidation in research," says Merrill spokesman Bill Halldin. A spokeswoman for Mr. Lay said he had no comment. What is undeniable is the close relationship between Merrill and Enron, which was the focus of a congressional hearing Tuesday. The hearing -- which focused on previously disclosed transactions Merrill did with Enron, as well as Mr. Olson's dealings with the former energy company -- has turned up the heat at Merrill and comes as federal investigators begin to zero in on the roles of big securities firms and banks in Enron's spectacular collapse last year. "Investors trusted you," Democrat Richard Durbin of Illinois said at Tuesday's hearing. "They believed you were the cop on the beat. Instead, you were the dog in the lap." G. Kelly Martin, president of Merrill's international-brokerage division, responded that the research process is "rigorous" and operates as a separate part of the firm. But he added, "We don't get everything right, as human beings."

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

From The Wall Street Journal Accounting Educators' Review on July 27, 2002

TITLE: Merrill Changes Methods Analysts Use for Estimates 
REPORTER: Karen Talley DATE: Jul 24, 2002 
TOPICS: Accounting, Earnings Forecasts, Financial Accounting, Financial Analysis, Financial Statement Analysis

SUMMARY: Merrill Lynch & Co. has reported that it will begin forecasting both GAAP based earnings estimates in addition to pro forma earnings measures. To accommodate Merrill Lynch & Co., Thomson First Call will collect and report GAAP estimates from other analysts.

1.) Compare and contrast GAAP earnings and pro forma earnings?

2.) Why do analyst forecast pro forma earnings? Will GAAP earnings forecasts provide more useful information than pro forma earnings forecasts? Support your answer.

3.) Discuss the advantages and disadvantages of analysts forecasting both pro forma and GAAP earnings. Should analysts continue to provide pro forma earnings forecasts? Should analysts also provide GAAP earnings forecasts? 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 pro forma reporting are at 

Citigroup, J.P. Morgan Chase: Big Fees and Favors in Enron Dealings --- 

“The evidence indicates that Enron would not have been able to engage in the extent of the accounting deceptions it did, involving billions of dollars, were it not for the active participation of major financial institutions willing to go along with and even expand upon Enron’s activities,” Roach said at the hearing of the investigative panel of the Senate Governmental Affairs Committee.

Both Citigroup, the nation's largest financial institution, and J.P. Morgan Chase have called the arrangements appropriate.

"The transactions we entered into with Enron were entirely appropriate at the time based on what we knew and what we were told by Enron," claimed a Citigroup announcement Tuesday on its Web site. "We were assured that Enron’s auditors had approved them and we believed they were consistent with accounting rules in place at the time."

Tuesday's tumble in stock prices for both Citigroup and J.P. Morgan Chase came as investigators for the Senate's Permanent Subcommittee on Investigations said Citigroup and J.P. Morgan Chase assisted Enron for years by lending the collapsed energy trader billions of dollars through disguised commodity trades. The Subcommittee also said that some banks, including Citigroup, helped Enron hide debt in the months prior to Enron's bankruptcy.

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

From the New York Stock Exchange --- 

The NYSE Board of Directors has approved new standards and changes in the corporate governance and practices of NYSE-listed companies.

The following is the principal text of the related rule filing submitted by the Exchange to the Securities and Exchange Commission on August 16, 2002.

August 16, 2002: Corporate Governance Rule Filing

June 6, 2002: Original Recommendations of the Corporate Accountability & Listing Standards Committee

Related Information:

August 2002 Newsletter Article: NYSE Approves Measures to Strengthen Corporate Accountability

Aug 1, 2002: Webcast of Nightly Business Report's CEO Roundtable

Aug 1, 2002 Press Release: NYSE Approves Measures to Strengthen Corporate Accountability

  July 9, 2002: NYSE's Dick Grasso Statement on President Bush's Speech on Corporate Responsibility

Your Market July 2002: Straight Talk for Investors from the New York Stock Exchange

June 20, 2002: Statement from NYSE Chairman and CEO Dick Grasso on SEC's Proposed Rules on Accounting Profession Oversight Board

June 2002 Newsletter: Accountability Report Sets Higher Bar

June 6, 2002 Press Release: NYSE Board Releases Report of Corporate Accountability and Listing Standards Committee

Related Regulations:

Press Info:

Research Analyst Conflict of Interest

Auditing Articles from ---,5509,775|2|1,00.html 


Audit Regulation
Beast or Burden?
August 01, 2002

Big Five Get Low Grades for Performance
Survey shows that auditors mostly fail to uncover bookkeeping irregularities, and often fail to warn about clients headed for Ch.11.
July 12, 2002

Is Auditor Rotation Coming?
Some lawmakers want companies to rotate their independent auditors. Is this such a good idea?
June 05, 2002

Teetering on the Brink -- But No Audit Warning
Report: auditors often fail to provide caution in filings of foundering companies; more likely to raise concerns about smaller clients.
April 25, 2002

Auditors Get a Near-Failing Grade, say Clients
Survey reveals rating for auditors lags far behind marks for other service providers. Corporate clients say value, not values, the problem.
April 12, 2002

Audit Committee Recruiting a Tough Sell
Can't give It away.
April 01, 2002

Wrong Numbers
The bank's telecom bill was cut by between 5 and 10 percent during the first year.
January 01, 2002

Are You the Gatekeeper? SEC's Hunt Reminds Auditors of Their Role
Commissioner worried investors may confuse pro forma results with audited financial statements.
October 30, 2001

Life in a Fishbowl
Audit committees have been under intense scrutiny -- and seem to be the better for it.
July 01, 2001

Let’s Get Ready to Rumble
SEC to vote Wednesday on auditor independence rule.
November 13, 2000

Continued at,5509,775|2|1,00.html  

The Securities and Exchange Commission (SEC) has filed charges against Adelphia Communications Corp. and arrested the founder and members of his family. 

Viewing telecom’s scandals through a forensic lens 
Anyone who cares to watch the evening news recalls the recent Justice Department publicity stunts involving Scott Sullivan, former chief financial officer for WorldCom, and several members of the Rigas family who founded Adelphia Cable. 

What AT&T sees in Qwest’s accounting

Qwest’s recently disclosed accounting irregularities amount to an admission that the company has been illegally offering long-distance service within its region, AT&T charged this week. AT&T made its allegations in motions filed with the Arizona and Minnesota public utility commissions.

James E. Copeland, Deloitte & Touche's chief executive officer, recently called for the creation of a National Financial Review Board (NFRB) to investigate business failures --- 

Aggressive Accounting Practices Examined --- 

Aug. 16, 2002 (The Internal Auditor) — A recent study suggests that aggressive accounting techniques -- or earnings management attempts -- such as those allegedly practiced by WorldCom and Xerox, may be common in the business world.

What ten companies have the most "inflated" measures of profit?

"Shining A New Light on Earnings, BusinessWeek Editorial, June 21, 2002 --- 

How much does a company truly make? It's hard to tell these days. To boost the performance of their stocks, companies have come up with a slew of self-defined "pro forma" numbers that put their financials in a favorable light. Now ratings agency Standard & Poor's has devised a truer measure known as Core Earnings.

The Goal: to provide a standardized definition of the profits produced by a company's ongiong operations. Of the three main changes from more traditional measures of profits two reduce earmings: Income from pension funds is excluded and the cost of stock options are deducted as an expense. The other big change boosts earnings by adding back in the charges taken to adjust for overpriced acquisitions. Here are the top 10 losers and winners under Core Earnings:

"IBM, Microsoft and Cisco cited in 'inflated profits' report:  At a loss to explain profits," Jon Bernstein,, July 2002 --- 

Three of IT's leading lights are overstating their financial health, according to a report from credit rating agency Standards and Poor's (S&P).

The report, which comes in the wake of the WorldCom affair, attempts to re-state the profits of a number of leading US firms in attempt to strip them down to 'core earnings'.

Using its own measure of profitability, S&P estimates that IBM's earnings for 2001 are down $2.87bn and Microsoft's are down $2.26bn. Meanwhile, Cisco's losses for 2001 stand at $2.52bn compared to the $1.01bn the company stated.

S&P says that US Inc has been boosting profits by excluding acquisition charges and including income from pension funds.

WorldCom faces collapse after a $3.8bn accounting fraud was exposed last week. WorldCom stands accused of treating running costs as capital expenditure.

For related news, see:
Xerox: the next WorldCom?
Worldcom - the winners and the losers
Worldcom-it is hits British university network
WorldCom fraud shock sends stock markets tumbling

Bob Jensen's threads on the S&P conceptualization of "core earnings" are at 

Enron's Empire:  How Government and International Agencies Used Taxpayers Money to Bankroll the Energy Giant's International Investments," by Daphne Wysham and Jim Vallette Special to CorpWatch April 11, 2002 --- 

The US public is only just beginning to comprehend the devastating domestic impact of Enron's financial machinations and dirty deals. However, the part of the story that has been eclipsed until now, is that Enron's international empire, which was fraught with charges of human rights and environmental abuses, was built on a foundation of about $7 billion in taxpayer money. This $7 billion came from institutions whose mandates range from poverty alleviation to promoting the US Merchant Marines or German exports, yet Enron convinced each that it was in their interest to promote the capitalization of Enron.

Since Enron's inception in 1992, at least 20 agencies, representing the U.S. Government (leading the way with over $3 billion), the British, Italian, French, German, and Japanese governments, as well as the Inter-American Development Bank, the European Union and the World Bank, approved $7 billion in financing toward overseas projects in which Enron had substantial involvement. Enron leveraged this public finance into a worldwide web of power and energy projects with an array of political interventions from local politicians to the Vice President of the United States. Enron's overseas operations rewarded shareholders temporarily but often punished the people and governments of foreign countries it targeted with price hikes and blackouts worse than those suffered by Californians in 2001.

In desperately poor countries where Enron operated, these hardships sparked protests or riots. Local government leaders were, in many cases, implicated in the scandals or in the violent suppression of dissent.

For example:

While all this was occurring, the US Government and other public agencies continued to advocate for Enron, threatening poor countries like Mozambique with an end to aid if they did not accept Enron's bid on a natural gas field. Enron was so intertwined with the US Government in many people's minds that they assumed, as the late Croatian strongman Franjo Tjudman did, that pleasing Enron meant pleasing the White House. For Tjudman, he hoped that compliance with an overpriced Enron contract might parlay into an array of political favors, from softer treatment at The Hague's War Crimes Tribunal to the entry of his country into the World Trade Organization.

Only when Enron's scandals began to affect Americans did these same government officials and institutions hold the corporation at arm's length. And only when Enron leadership revealed their greed on home turf did it became the biggest corporate scandal in recent US history.

The World Bank and Enron: A Converging Agenda

The history of Enron's rise and fall would be incomplete without some background on the public agencies that assisted the corporation in its global expansion. It is important to begin with the World Bank, this institution more than any other often creates an agenda that other bilateral and multilateral development banks follow.

The World Bank began investing in oil and gas following on the heels of the Organization of Petroleum Exporting Countries (OPEC) oil embargo and oil price shocks of the 1970s. The rationale for this investment was clear: The US, an oil- and gas-dependent nation with limited indigenous sources of oil, needed to diversify its sources of non-OPEC oil and gas. Administration officials were concerned that OPEC had a virtual monopoly on the fuels, and could raise prices at whim, sending shockwaves throughout the global economy. The secondary concern, particularly for Northern investors, was the fact that, as oil prices rose, so, too, did developing countries' inability to service their debt. The U.S. worried that these countries, already strapped for cash, would default on their loans.

And so it was just days after former President Ronald Reagan assumed office in January 1981 that their administration began dismantling World Bank conventions and initiatives. One of the first areas to which the Reagan administration turned its attention was the World Bank's investment in the energy sector. The Bank had revealed its intention to increase investments in energy, but the US Treasury wrote that, without deregulation and privatization of the oil and gas industry abroad, such investment would support regimes that were not friendly to private investors and multinational oil companies.

In a report entitled, An Examination of The World Bank Energy Lending Program, the office of the US Treasury's Assistant Secretary prescribed measures the World Bank should take to encourage private investment in oil and gas development. The report's authors noted that the World Bank, perceived as a neutral third party, would be more successful in advancing this agenda than the US, at little or no cost.

Here is how it worked: The World Bank would issue loans for privatization of the energy or the power sector in a developing country or make this a condition of further loans, and Enron would be amongst the first, and often the most successful, bidders to enter the country's newly privatized or deregulated energy markets. The US Commerce Department, State Department, or Energy Department would then send officials to meet with politicians in the targeted country. After meeting with these officials, deals would mysteriously turn in Enron's favor. Sometimes suspicions would be raised by the amazing deals Enron would strike -- purchasing power plants or buying shares in a gas field at vastly undervalued prices. Perhaps a politician or two would be exposed and be forced to resign. But soon thereafter the public finance would begin to flow -- from US and other export credit agencies, multilateral development banks, and private financiers. And another project would be on its way.

The Dominican Republic

One specific case in point is the Dominican Republic. In the early 1990s, the Dominican Republic opened its doors to independent power producers, to help the cash-strapped country produce power for its citizens. On July 22, 1994, the World Bank's IFC approved a $132.3 million loan, and a year later, an additional $1.5 million currency swap, in support of a 185-megawatt combined-cycle power facility mounted on a barge at Puerto Plata. The barge-mounted power plant was owned by Enron's subsidiary, Enron Global Power & Pipelines, which acquired the parent company's 50% share in the barge power plant in 1995.1

In December of 1996, the U.S. Maritime Administration (MARAD) provided a $50 million guarantee toward two Enron power barges for this project.2 In January 1998, the World Bank's IBRD approved a $20 million loan to privatize the country's power sector. The goal, said the World Bank, was to open up the power sector to private companies, through reforms at the state agency, Corporacion Dominica de Electricidad (CDE).

When the government privatized its power sector, Enron (along with several other firms) rushed in to buy a stake in the generating capacity of the Dominican Republic, while AES and Union Fenosa of Spain bought into the distribution networks. Shortly after the private companies took over, power rates skyrocketed by 51-100% or more. Consumers refused to pay the higher rates, and ultimately forced the government to absorb most of the tariff increase.

As a result, the government paid around $5 million per month to the power companies, with an accumulated debt of more than US $135 million. The mounting debts in turn caused Enron and others to turn off the power, with blackouts sometimes lasting as much as 20 hours, affecting hospitals, businesses, and schools. By early 2001, widespread frustration with the situation triggered protests, some of which turned violent after police clashed with demonstrators. At least nine people died in the protests, including a 14-year-old boy.

In June 2001, the President of the Dominican Republic announced that the contracts awarded during the privatization of the power sector would be investigated. In a situation with similarities to California's 2001 energy debacle, shortages were originally blamed on private power generators, which at the time of the crisis were only supplying a little less than half of the 815,000 kilowatts they were capable of producing. The electricity issue also sparked a confrontation between the Dominican government and the U.S. Embassy, after the former accused the Smith-Enron joint venture of outright fraud for failing to deliver its promise to generate at least 175 megawatts a day.3

Officials of the current and previous administration have been publicly trading responsibility for the chaos in the electricity sector. Meanwhile a familiar name has turned up in a report done for the Dominican Republic's Senate. The Senate report claimed that the assets of the CDE had been undervalued by $2.1 billion. It questioned whether the payment from the private companies had ever entered the country. The auditor who valued these public assets at such fire sale prices? A local subsidiary of Arthur Andersen.

Some Lessons

After a detailed study of Enron's overseas activities over the past decade in 27 countries, Institute for Policy Studies researchers have reached the following 4 conclusions:

1. Using taxpayer monies, US Government agencies were the largest backers of Enron's activities abroad.

Although Enron-related projects obtained more than $7 billion in public financing from all over the world from 1992 to 2001, US Government agencies (the US Overseas Private Investment Corporation, Export-Import Bank, the US Maritime Administration Trade and Development Agency) lead the way with $3.4 billion in support of Enron-related projects abroad. This assistance, and other, less tangible favors, was provided by US officials and institutions despite widespread evidence of Enron's involvement in fraud, corruption, and human rights abuses.

2. The World Bank was the second largest supporter of Enron projects abroad.

Despite some reluctance to support several deals obviously favorable to Enron, the World Bank did provide $745 million in support for Enron-related overseas projects from 1992 to 2001. Beyond direct support for specific projects, it also provided Enron an entre to many developing countries by pushing its agenda of privatization and deregulation of the energy and power sectors as conditions on further loans.

3. When the World Bank or US agencies decided Enron's projects were financially or politically untenable, other export credit agencies and regional financial institutions eagerly stepped into the breach.

A host of development and aid agencies -- from the multilateral European Investment Bank and the Inter-American Development Bank to the bilateral Commonwealth Development Corporation of the UK -- provided over $3 billion in financing for 19 Enron-related projects, adding non-US Government taxpayer support to Enron's risky ventures abroad.

4. Enron's collapse calls into question the policy of energy deregulation that Enron, together with its partners in the United States Government, the World Trade Organization (WTO), the International Monetary Fund (IMF) and World Bank have advocated domestically and worldwide.

The World Bank and IMF have been pursuing deregulation and privatization of the power and energy sectors for two decades. Energy deregulation has resulted in the energy needs of the vast majority of citizens-the poorest as well as those in need of power for businesses, hospitals, schools and other public services to function-being routinely sacrificed for private gain. So long as the World Bank, IMF, WTO, US Government and corporations continue to advance this agenda of energy and power deregulation, all signs suggest that future "Enrons" will continue to occur, with devastating public consequences.


  1. For further details on the ownership struggle at the Puerto Plata plant, see court case: Smith/Enron Cogeneration Ltd Partnership, Enron International, et al., vs. Smith Cogeneration International Inc., United States Court of Appeals for the Second Circuit, Docket No. 99-7101, Argued Sept. 15, 1999, Decided Dec. 8, 1999.

  2. MARAD approved guarantees to build three power barges for this project. In 1994, MARAD approved a $34.3 million guarantee for McDermott's construction of one barge mounted power plant for the Puerto Plata project. In 1996, MARAD approved a $50 million guarantee toward the construction of two Smith-Enron barge mounted power barges constructed (TK) by Trinity Marine of Beaumont, Texas.

  3. PSIRU Enron Report, June 2001

Accounting firm KPMG has been reprimanded and fined by the Institute of Chartered Accountants in Ireland for what the Institute described as an audit that "in terms of efficiency and competence fell below the standards to be expected." 

Accounti8ngWeb ---,%20%Y (Requires Subscription)

KPMG Gets Probation For Bungling Orange County Audit
AccountingWEB US - July 29, 2002 -  International accounting firm KPMG has been slapped with a $1.8 million fine and a year of probation after being found guilty of gross negligence and unprofessional conduct for its handling of the 1992 and 1993 audit and financial statements of Orange County, California. The California Board of Accountancy also ordered three years of probation and 100 hours community service for KPMG partner Margaret Jean McBride and two years of probation each for former KPMG accountants Joseph Horton Parker and Bradley J. Timon. All were found guilty of gross negligence and unprofessional conduct.

The county declared bankruptcy in late 1994 after it lost $1.7 billion in its investment pool. County treasurer Robert L. Citron oversaw the investment pool. Mr. Citron was convicted of faking interest earnings and falsifying accounts. The Board claims that KPMG, attempting to save money on what turned out to be an underbid audit, cut corners by allowing junior staff members to conduct certain areas of the audit and by not helping the county solve its problem of a lack of internal controls with regard to the investment pool. KPMG auditors did not speak with the county treasurer regarding the investment pool, nor did they determine the true market value of the highly leveraged and speculative investments. KPMG paid a settlement of $75 million to Orange County in 1998.

KPMG refutes the claims and says the accountancy board wasted millions of dollars with the goal of making KPMG a scapegoat. "The claims by the board incorrectly challenge how KPMG reached its conclusions rather than claim our conclusions were wrong," said KPMG spokesman George Ledwith.

Continued at the AccountingWeb link shown above.

Bob Jensen's threads on the Orange County and other derivative instrument frauds can be found at 

Bob Jensen's threads on accounting scandals can be found at 

The 800 Pound Gorilla (TIAA-CREF) Makes a Move Toward Revising GAAP 

The largest lobbying effort to stave off having to book employee stock options as expenses comes from technology firms who claim that such a move will destroy the technology industry by making it very difficult for them to show a profit.  But pressure is coming from other corporations.  Only two of the Fortune 500 firms (Boeing and Winn Dixie) booked stock options as expenses until several like Coca Cola recently announced a shift.

Standard & Poors announced it will disclose the impact of stock options on earnings in its presentation of "S&P Core Earnings" of major companies --- 
Of course this data is available in footnotes thanks to the brave efforts to generate FAS 123 when Denny Beresford was Chairman of the FASB.

Bob Jensen's arguments for booking employee compensation options as expenses can be found at 

The International Accounting Standards Board (IASB) is now moving toward booking of options as expenses.  It will take a very courageous FASB and SEC to renew the fight in the face of the millions being spent by lobbyists in Washington to block this effort.  Even though I favor booking employee compensation options as expenses, I have to admit that technology industry earnings take a huge hit under FAS 2 by having to book virtually all R&D expenditures as expenses long before products have a chance of generating revenues.  Industry balance sheets also take a beating by not being able to book intangible assets such as knowledge capital.  See 

"TIAA-CREF Wants Options To Be Considered Expenses," by Joann S. Lublin, The Wall Street Journal, July 23, 2002 ---,,SB1027468213695010720,00.html?mod=home_whats_news_us 

NEW YORK -- One of the nation's biggest institutional investors is launching an unprecedented drive to persuade U.S. companies that they should treat all employee stock options as expenses.

TIAA-CREF intends to send a letter Wednesday to the chairmen of 1,754 major publicly traded corporations, urging them to discuss its recommendation with fellow board members. Voluntary expensing of options "contributes to clear, straightforward and high-quality financial reporting, enhancing credibility that surely will be highly valued in the post-Enron market," wrote John H. Biggs, TIAA-CREF chairman, president and chief executive, in his letter.

The missive marks the first time the giant pension-fund system has asked so many companies to take corrective action, said Kenneth Bertsch, corporate-governance director. TIAA-CREF owns about 1% on average of the shares outstanding of the targeted concerns.

The push by TIAA-CREF, which manages $265 billion of assets, seems certain to increase pressure on businesses to follow the recent decisions by Coca-Cola Co., Washington Post Co., Bank One Corp. and AMB Property Corp. to begin recording stock options as an expense. The move reduces corporate earnings and would make stocks look more expensive. Right now, most U.S. companies simply disclose in a footnote the bottom-line effect of options granted to employees.

"There's some momentum beginning to gather for companies to compile quality earnings reports and include this information" as an expense, Mr. Biggs said in an interview Tuesday. "I think this letter will encourage that momentum," he continued. "We could get a snowball going."

Indeed, the TIAA-CREF campaign may inspire copycat lobbying efforts. "We would consider doing something similar" by writing those nearly 1,800 concerns plus several others, predicted Ann Yerger, research director for the Council of Institutional Investors. The Washington group represents more than 130 pension funds with more than $2 trillion in assets.

After a two-year study, the Council of Institutional Investors reversed course last March and endorsed the idea that options should be treated as an expense. Proponents of expensing say options are compensation and should be treated as such, especially since generous option awards dilute the value of shares outstanding. Opponents say options are difficult to value and argue that expensing them would confuse, not enlighten, investors.

Mr. Biggs said he believes "there's a good chance" his letter will prompt another 15 to 20 prominent concerns to switch their approach. And he welcomed the possibility of intensified pressure. "The more institutional investors we get to pile on, the better off we will be," he said. He recalled how TIAA-CREF has quietly lobbied individual companies about this issue for years -- with little success.

Ms. Yerger is less optimistic many corporate boards will change their stance now. Accounting treatment of options "is a highly emotional issue," she observed. Most businesses "aren't going to switch just because of a few letters" from major institutional shareholders.

High-tech concerns in particular rely heavily on stock options. The TIAA-CREF letter "will be taken seriously" by such companies, said Mike Tanielian, vice president of government relations for the Information Technology Industry Council, a trade association in Washington. But high-tech businesses "still feel it's important to provide broad stock-option plans" -- something they probably couldn't afford to do if they treated options as an expense, he said.

Despite the zeal on Capitol Hill for corporate reforms in the wake of Enron Corp.'s collapse and other corporate scandals, heavy lobbying by the high-tech industry dissuaded Congress from tackling the controversial issue of options expensing this month.

On the other hand, a rule-setting group charged with creating a set of international accounting standards last week approved the drafting of new accounting rules that would require companies to treat options as expenses. The move was cleared by the London-based International Accounting Standards Board.

The 1930s saw high-profile companies go bust, business leaders fall into disrepute, and the stock market crumble -- all leading to sweeping changes in the way business and finance were conducted. Are we on the verge of a similar period of reforms today?

"Reform Redux: What Could Bring A 1930s-Style Regulatory Overhaul?," by Gerald F. Seib and John Harwood, The Wall Street Journal, July 23, 2002 ---,,SB1027457561514609800,00.html?mod=Page%20One 

WASHINGTON -- High-profile companies go bust. Business leaders fall into disrepute. The stock market crumbles. Finally, the political system convulses, rewriting the rules the corporate world must follow.

All that happened to the U.S. in the early 1930s, when a shattered economy, a devastated stock market and revulsion toward the business class produced sweeping changes in the way business and finance were conducted.

Now America faces the possibility of a similar wave of reform, if the economy sours and the political winds shift. Today's economic woes hardly rival those of the 1930s, and Congress's rush to clamp down on corporate misconduct is mild compared with the legislative earthquake that shook the business world then. But the country is beginning to reappraise the celebration of free-market forces that marked the 1990s. And early political tremors of public opinion hint at greater fallout to come.

A new Wall Street Journal/NBC News poll shows that, for the first time since George W. Bush took office, a plurality of Americans -- 42% -- believe the country is headed in the wrong direction. Fully 70% don't trust the word of brokers and corporations. One-third say they have "hardly any confidence" in big-company executives -- the highest proportion in more than three decades. Confidence in Congress is plummeting, too. Just 34% approve of lawmakers' performance, down from 54% in January.

Political momentum to restrain government regulation is waning. As they await the government's response to a wave of business scandals, six in 10 Americans say they are worried regulators won't go far enough.

AFL-CIO President John Sweeney calls this the best chance in years "to fundamentally change the way corporate America works." And free-market apostles, ascendant since Ronald Reagan's presidency, fear that even a Republican White House may join a populist stampede. If that happens, "they're going to have a depression on their hands," warns author George Gilder, whose 1981 book, "Wealth and Poverty," is still popular with many conservatives. "If Bush becomes part of the echo chamber, he's going to destroy his party."

The 2002 market meltdown could turn into a historic turning point in American politics and regulation if two significant changes occur.

First, the current crisis of confidence in business and markets would have to turn into a broader economic decline. When Franklin Roosevelt embarked on the New Deal, one in four Americans was out of work, four times today's unemployment rate. The spread of stock ownership means Main Street is feeling Wall Street's pain, but so far, that pain has produced public anger -- not desperation.

Second, the economic shock would have to realign the nation's even balance of political power to give politicians the clear mandate for change that President Roosevelt and his Democratic Party felt. That hasn't happened yet, the new poll shows. Mr. Bush continues to enjoy a robust 67% approval rating, and his party is still holding its own in the battle for control of Congress in the November elections. Some 36% of Americans say they plan to vote Democrat for the House, while 34% plan to vote Republican. That is only a slight change since January, favoring the Democrats.

But sweeping political change doesn't come overnight, as the 1920s and 1930s show. The country knew it was in deep trouble after the stock market crashed in 1929. The Democratic Party gained 53 seats in the House elections in 1930, but Republicans narrowly retained control of the chamber. The GOP also maintained a one-seat edge in the Senate, while Republican President Herbert Hoover looked ahead to the last two years of his White House term.

Tidal Wave

The political tidal wave didn't hit until 1932, three years after the start of the economic shock. Republicans lost 101 more seats in the House, which as a result, tilted toward the Democrats by a 313-117 margin. The GOP also lost 12 more Senate seats and became a distinct minority there, too. FDR completed the Democratic sweep with his 1932 landslide.

That new political alignment produced, in rapid order, the Securities and Exchange Commission, the Glass-Steagall Act separating the banking and investment businesses, the Utility Holding Company Act restricting the centralization of utility control, and reform of the Federal Reserve. It was the most sweeping change ever in the way America does business, and it created the regulatory framework that still governs business today.

It's that framework that lawmakers are now adjusting in the accounting-reform bill before Congress. "Our crisis isn't of the same dimension" as in the 1930s, says Sen. Jon Corzine, a former co-chairman of Goldman Sachs. But the accounting-reform bill likely to pass Congress next month is "probably as important a piece of legislation for America and the regulatory structure as any since then," adds the New Jersey Democrat. It plugs what he considers the most significant hole left in the 1930s legislation by establishing clear standards and oversight for the accounting industry.

Continued at,,SB1027457561514609800,00.html?mod=Page%20One

Until recently, pro forma reporting was seen as a useful tool that could help companies show performance when unusual circumstances might cloud the picture. Today it finds itself in bad odour. 
"Pro forma lingo Does the use of controversial non-GAAP reporting by some companies confuse or enlighten?," by Michael Lewis, CA Magazine, March 2002 --- 

For fans of JDS Uniphase Corp., the fibre-optics manufacturer with headquarters in Ottawa and San Jose, Calif., the report for fiscal 2001 provided the icing on a very delicious cake: following an uninterrupted series of positive quarterly earnings results, the corporate giant announced it was set to deliver US$67 million in pro forma profit.

There was only one fly in the ointment. Like all such calculations, JDS's pro forma numbers were not prepared in accordance with generally accepted accounting principles (GAAP), and as such they excluded goodwill, merger-related and stock-option charges, and losses on investments. Once those items were added back into the accounting mix, JDS suddenly showed a staggering US$50.6 billion in red ink - a US corporate record. Even so, many investors remained loyal, placing their trust in the boom-market philosophy that views onetime charges as largely irrelevant. The mantra was simple - operating results rule.

"That was the view at the time," says Jim Hall, a Calgary portfolio manager with Mawer Canadian Equity Fund. "It just goes to show how wrong people can be."

Since then, of course, the spectacular flameout of Houston's Enron Corp. has done much to change that point of view (though it's not a pro forma issue). Once the world's largest energy trader, the company now holds the title for the largest bankruptcy case in US history. The Chapter 11 filing in December came after Enron had to restate US$586 million in earnings because of apparent accounting irregularities. In its submission, the company admitted it had hidden assets and related debt charges since 1997 in order to inflate consolidated earnings. Enron's auditor, accounting firm Arthur Andersen LLP, later acknowledged that it had made "an [honest] error in judgement" regarding Enron's financial statements.

While the Enron saga will continue in various courtrooms for many months to come, regulators on either side of the border have responded to the collapse with uncharacteristic swiftness. Both the Securities and Exchange Commission (SEC) in the United States and the Canadian Securities Administrators (CSA) issued new guidelines on financial reporting just a few weeks after the Enron bust. In each instance, investors were reminded to redirect their focus to financial statements prepared in accordance with GAAP, paying special attention to cash flow, liquidity and the intrinsic value of acquisitions. At the same time, issuers were warned to reduce their reliance on pro forma results and to explain to investors why they were not using GAAP in their reporting.

SEC chairman Harvey Pitt moved furthest and fastest. In mid-January he announced plans to establish a private watchdog to discipline accountants and review company audits. Working with the largest accounting firms and professional organizations such as the American Institute of Certified Public Accountants (AICPA), the SEC wants the new body to be able to punish accountants for incompetence and ethics violations. As Pitt emphasized, "The commission cannot, and in any event will not, tolerate this pattern of growing re-statements, audit failures, corporate failures and investor losses."

The sheer scale of the Enron debacle has brought pro forma accounting under public scrutiny as never before, and, observers say, will provide a powerful impetus for financial reporting reform. "This will send a message to companies and accountants to cut back on some of the games they've been playing," says former SEC general counsel Harvey Goldschmid.

Meanwhile, the CSA (the forum for the 13 securities regulators of Canada's provinces and territories) expressed its concern over the proliferation of non-standard measures, warning that they improve the appearance of a company's financial health, gloss over risks and make it exceedingly difficult for investors to compare issuers.

"Investors should be cautious when looking at non-GAAP measures," says John Carchrae, chair of the CSA Chief Accountants Committee, when the guidelines were released in January. "These measures present only part of the picture and may selectively omit certain expenses, resulting in a more positive portrayal of a company's performance."

As a result, Canadian issuers will now be expected to provide GAAP figures alongside non-standard earnings measures, explain how pro forma numbers are calculated, and detail why they exclude certain items required by GAAP. So far, the CSA has provided guidance rather than rules, but the committee cautions it could take regulatory action if issuers publish earnings reports deemed to be misleading to investors.

Carchrae, who is also chief accountant of the Ontario Securities Commission (OSC), believes "moral suasion" is a good place to start. Nonetheless, he adds, the OSC intends to track press releases, cross-reference them to statutory earnings filings and supplemental information on websites, and monitor continuous disclosure to ensure a company meets its requirements under the securities act.

Although pro forma reporting finds itself in bad odour, until recently it was regarded as a useful tool that could help companies show performance when unusual circumstances might cloud the picture. In cases involving a merger or acquisition, for example, where a company has made enormous expenditures that generate significant non-cash expenses on the income statement, pro forma can be used as a clarifying document, enabling investors to view economic performance outside of such onetime events. Over the years, however, the pro forma route has increasingly involved the selective use of press releases, websites, and other reports to put a favourable spin on earnings, often leading to a spike in the value of a firm's stock. Like management discussion and analysis, such communications are not within the ambit of GAAP, falling somewhere between the cracks of current accounting standards.

"Obviously, this issue is of concern to everyone who uses financial statements," says Paul Cherry, chairman of the Canadian Institute of Chartered Accountants' Accounting Standards Board. "Our worry as standard-setters is whether these non-GAAP, pro forma items confuse or enlighten."

Regulators and standard-setters have agonized over this issue ever since the reporting lexicon began to expand with the rise of the dot-com sector in the late 1990s, a sector with little in the way of earnings that concentrated on revenue growth as a more meaningful performance indicator. New measures, such as "run-through rates" or "burn rates," were deemed welcome additions to traditional methodology because they helped determine how much financing a technology company might require during its risky startup phase.

Critics, however, argued such terms were usurping easily understood language as part of a corporate scheme to hoodwink unwary investors. Important numbers were hidden or left out under a deluge of new and ever-more complex terminology. The new measurements, they warned, fell short of adequate financial disclosure.

An OSC report published in February 2001 appears to support these claims. According to the report, Canadian technology companies have not provided investors with adequate information about how they disclose revenue, a shortcoming that may require some of them to restate their financial results.

"Initial results of the review suggest a need for significant improvement in the nature and extent of disclosure," the report states, adding that the OSC wants more specific notes on accounting policy attached to financial statements. The report also observes that revenue is often recognized when goods are shipped, not when they are sold, despite the fact that the company may be exposed to returns.

David Wright, a software analyst at BMO Nesbitt Burns in Toronto, says dealing with how technology companies record revenue is a perennial issue. The issue has gained greater prominence with the rise of vendor financing, a practice whereby companies act as a bank to buyers, lending customers the cash to complete purchase orders. If the customer is unable to pay for the goods or services subsequent to signing the sales agreement, the seller's revenue can be drastically overstated.

But pro forma still has plenty of advocates - particularly when it comes to earnings before interest, taxes, depreciation and amortization (EBITDA). Such a measure, it is often argued, can provide a pure, meaningful and reliable diagnostic tool, albeit one that should be considered along with figures that accommodate charges to a balance sheet.

Ron Blunn, head of investor relations firm Blunn & Co. Inc. in Toronto and chairperson of the issues committee of the Canadian Investor Relations Institute, says adjusted earnings can serve a legitimate purpose and are particularly helpful to analysts and money managers who must gauge the financial well-being of technology startups.

The debate shows no signs of burning out anytime soon. On the one hand, the philosophy among Canadian and US standard-setters in recent years has appeared to favour removing constraints, rather than imposing them. New rules to apply to Canadian banks this year, for example, will no longer require the amortization of goodwill in earnings figures. On the other hand, it has become abundantly clear that companies will emphasize the reporting method that puts the best gloss on their operations. And while the use of pro forma accounting has remained most prevalent among technology companies, the movement to embrace more and varied language has spread to "old economy" companies such as Enron, gaining steam as the economy stumbled. Blunn theorizes the proliferation of nontraditional reporting and the increasing reliance on supplemental filings simply reflect the state of the North American economy.

Carchrae has a slightly different diagnosis. When asked why pro forma reporting has mushroomed in recent years, he points to investors' slavish devotion to business box scores - that is, a company's ability to meet sales and earnings expectations as set out by equity analysts. Since companies can be severely punished for falling short of the Street's consensus forecast, there is intense pressure, especially in a bear market, to conjure up earnings that appear to satisfy forecasts.

As a result, pro forma terminology has blossomed over the Canadian corporate landscape. Montreal-based telephone utility BCE Inc., for example, coined the term "cash baseline earnings" to describe its operating performance. Not to be outdone, Robert McFarlane, chief financial officer of Telus Corp., Canada's second-largest telecommunications company, cited a "revenue revision" and "EBITDA deficiency" to explain the drop in the Burnaby, BC-based phone service firm's "core baseline earnings" for its third quarter ended September 30, 2001. (According to company literature, core baseline earnings refers to common share income before discontinued operations, amortization of acquired intangible assets net of tax, restructuring and nonrecurring refinancing costs net of tax, revaluation of future tax assets and liabilities and goodwill amortization.)

Meanwhile, IBM Corp. spinoff Celestica Inc. of Toronto neglected to mention the elimination of more than 8,700 jobs from a global workforce of 30,000, alluding to the cuts in its fiscal 2001 third-quarter report through references to "realignment" charges during the period.

Many statements no longer use the term "profit" at all. And while statutory filings must present at least one version of earnings that conforms to GAAP, few rules have been set down by US or Canadian regulators to govern non-GAAP declarations. Accounting bodies in Canada and around the world are charged with policing their members and assuring statutory filings include income and revenue according to GAAP, using supportable interpretations. But pro forma numbers are typically distributed before a company's statutory filing is made.

"Not to pass the buck," says Cherry, "but how can we set standards for something that's not part of GAAP?" Still, Cherry admits the use of non-GAAP terminology has become so widespread that accounting authorities are being forced to take notice. "The matter is gaining some prominence," he says, "because some of the numbers are just so different."

Despite his reservations, Cherry acknowledges "the critical point is when information is released to the marketplace," which nowadays is almost always done via a press release. The duty to regulate such releases, he says, must rest with securities bodies - an opinion shared by Edmund Jenkins, chair of the Financial Accounting Standards Board (FASB) in the United States.

Many authorities view the issue as a matter of education, believing that a high degree of sophistication must now be expected from the retail investing community. Others say the spread of non-GAAP reporting methodology, left unchecked, could distort markets, undermine investor confidence in regulatory regimes and ultimately impede the flow of investment capital. But pro forma devotees insist that introducing tough new measures to govern reporting would do little to protect consumers and encourage retail investment. Instead, new regulations might work to impede growth and limit available, useful financial information.

Continued at 

Ron Baker shares his views of what will be needed in the accounting firm of the future in this overview of his session at the recent Association for Accounting Marketing conference. 

Congressman Edward Markey blasted the Securities and Exchange Commission for its "dead wrong" decision to allow IBM to keep PricewaterhouseCoopers as its auditor after acquiring PwC's consulting practice. (Requires Subscription)

From the FEI Research Foundation on July 25, 2002

Read an HTML version of this issue, and see an archive of previous issues, at

Welcome to the July 2002 edition of Private Net. If you have suggestions for future issues of Private Net, please send your ideas by e-mail to If you are interested in becoming a corporate sponsor of Private Net, please contact Nora Peyton at

In 2001, the SEC amended its auditor independence rules for SEC registrants for the first time since 1983. These rules, which became effective February 5, 2001, identified nine areas of non-audit services that could impair auditor independence. For example, bookkeeping services by the external auditor were prohibited. Here is the link to the "Final Rule: Revision of the Commission's Auditor Independence Requirements":

At the time, then SEC Chairman Arthur Levitt said that the rules would pertain only to publicly traded companies, and would have no direct impact on local audit firms and their clients. However, in an article in the June Issue of The CPA Journal, Nicholas J. Mastracchio, Jr., associate professor of accounting at the University at Albany, NY, warns that there could be a "trickle-down" effect to smaller audit firms and their clients.

In his article, "Independence and the Users of Closely Held Companies' Financial Statements", Dr. Mastacchio reviews the results of a survey of lenders with total assets of less than $200 million. There were 56 responses to the survey, of which 85% reported that more than three-quarters of their loans were to closely held companies.

Among the key findings of this survey, 96% of the respondents said that the CPA firms they came in contact with showed integrity, and 45% of the respondents thought that the majority of their closely held customers relied on their accounting firm for consulting services beyond tax and financial statements.

Consistent with most other views, tax services were not considered to be an impediment to independence. However, in direct contrast to the SEC's opinion, more controversial areas, such as information system design, internal auditing, and valuation services, were considered to enhance the audit.

Hiring non-financial personnel and bookkeeping staff did not pose problems for the respondents. Interestingly, fewer respondents thought that hiring non-accounting staff enhanced the auditors' activity.

Here is a link to the article:

(This link does not yet include two exhibits outlining respondents' opinions on how auditor independence is affected by consulting services and referral fees. Please call Bill Sinnett at 973-898-4604 if you would like him to fax you the exhibits.)

Merrill Lynch has announced additional enhancements to its fundamental equity research products. Effective immediately, Merrill Lynch is requiring all U.S. equity research reports to include earnings based on generally accepted accounting principles (GAAP) in addition to any pro forma earnings that companies may report. Click through to for further brief details


CEO and CFO Certify Financial Statements; Firm Already in Compliance With New Regulatory Proposals; Stock Options to Be Expensed 

NEW YORK, 13 August — Merrill Lynch (NYSE:MER) today announced further steps to strengthen its corporate governance and financial reporting.

The company has submitted certifications attesting to the accuracy of its financial statements as newly required by both the U.S. Securities and Exchange Commission and the Sarbanes-Oxley Act recently passed by the Congress. David Komansky, chairman and chief executive officer, and Tom Patrick, chief financial officer, signed and submitted the certifications last Friday, 9 August.

Messrs. Komansky and Stan O'Neal, president and chief operating officer, noted that Merrill Lynch is in compliance with virtually all of the policies and procedures embodied in new proposals by the New York Stock Exchange as well as those mandated by the regulators and the Congress.

"We have a long tradition of strong corporate governance," they said. "For example, we already have in place nearly all of the NYSE proposals."

Among specifics:

Messrs. Komansky and O'Neal noted that Merrill Lynch has long required shareholder approval of equity-based compensation plans for executives. "A new rule calls for shareholder approval of such plans for all employees — and we will comply," they said.

As part of an industry-wide initiative, Merrill Lynch also said it will expense stock options on its income statement in the future, under a methodology to be developed, making it one of a group of leading financial services firms to publicly announce the action.

"This decision is one of a series of steps we have taken and will continue to implement to help build public confidence in American business," said Messrs. Komansky and O'Neal. "We are joining other leading financial firms in committing to the development and application of a uniform and consistent method of expensing options — with an appropriate transition period." The company expects the change to be effective for stock options granted for the performance year 2003.

The company also noted that in the last two weeks Merrill Lynch's Global Securities Research & Economics Group has initiated important new measures to help investors better evaluate the financial performance of companies covered by the firm.

"We are requiring all U.S. equity research reports to include earnings based on generally accepted accounting principles (GAAP) in addition to any pro forma earnings that companies may report," said Messrs. Komansky and O'Neal. "We also have identified six key income statement and balance sheet measures that will be incorporated as appropriate into our research reports to help investors better evaluate the quality of a company's reported numbers."

These new measures "are above and beyond" a number of far-reaching research standards adopted by Merrill Lynch earlier this year to strengthen the clarity, independence and objectivity of its research.

"Financial institutions are the window through which investors see the capital markets. It's incumbent on firms like ours to lead by example in the way we operate internally and in the way we conduct business," they said. "We are committed to doing everything we can to help build investor confidence — in Merrill Lynch and in the financial markets."

Merrill Lynch is one of the world's leading financial management and advisory companies, with offices in 37 countries and total client assets of approximately $1.4 trillion. As an investment bank, it is a leading global underwriter of debt and equity securities and a leading strategic advisor to corporations, governments, institutions and individuals worldwide. Through Merrill Lynch Investment Managers, the company is one of the world's largest managers of financial assets, with approximately $500 billion in assets under management. For more information, please visit

"Real Accounting Fraud," by James M. Sheehan, Ludwig Von Mises Institute, August 18, 2002 --- 

Because the U.S. government is ratcheting up the regulation of accounting standards, earnings quality will actually suffer. With the threat of SEC investigations and lawsuits, no company will be able to make risky forecasts or assumptions in its financial reports. Therefore, internal forecasts and assumptions the company actually uses in its internal planning will be totally excluded from management’s discussion and analysis of its own books. Information that is potentially valuable to investors will tend not to be disclosed, lest the forecasts turn out to be slightly flawed or mistimed. CEOs do not want to be criminally prosecuted for possible errors by their employees.

The government class is set to amass tremendous new powers over accounting. Because it does not understand accounting, or apply any kind of accounting standards to itself, it does not even realize how its rules will only make things worse. When the unintended consequences come to pass, expect politicians to demagogue the issue and propose even more stringent regulatory controls. They understand little about business, but they do understand that more regulation ultimately equals more campaign contributions.

FYI on ethics in Strategic Finance

-----Original Message----- 
From: neal hannon [mailto:nhannon@COX.NET]  S
ent: Tuesday, August 20, 2002 11:09 AM To: AECM@LISTSERV.LOYOLA.EDU Subject: Re: Ethics cases

Hi Damon,

One place that can help you to prepare an ethics module is the Institute of Management Accountants' (IMA) Ethics Center, located at 

If you click on the resources link, you will find 32 articles on ethics that have been recently published in Strategic Finance magazine. In addition, there are two case studies written by Joan Elise Dubinsky and the The Rosentreter Group that are free to use. Enjoy!

Neal J. Hannon, CMA
Chair, XBRL International Education Work Group Chair, Information Technology Committee, Institute of Management Accountants Member, XBRL_US Steering Committee University of Hartford Accounting Department 401-769-3802 (Home Office)


Forwarded by Sherman Zelinsky


In 1923, a group of the world's most successful financiers met at the Edgewater Beach Hotel in Chicago.  Present were:

  1. The president of the largest independent steel company (Bethlehem Steel) 

  2. The president of the largest utility company

  3. The greatest wheat speculator

  4. The president of the New York Stock Exchange

  5. A member of the President's cabinet

  6. The greatest "bear" in Wall Street

  7. The president of the Bank of International Settlements

  8. The head of the world's greatest monopoly

Collectively, these tycoons controlled more wealth than there was in the United States Treasury and for years, newspapers and magazines had been printing their stories and urging the youth of the nation to follow their examples. Years later, let's see what happened to these men.

The president of the largest steel company (Charles Schwab) lived on borrowed money the last five years of his life and died broke.

The utility operator (Samuel Insull) died virtually in exile.

The greatest wheat speculator (Arthur Cutten) died abroad, insolvent.

The president of the New York Stock Exchange (Richard Whitney) served a term in Sing Sing.

The member of the President's cabinet (Albert Fall) was pardoned from prison so that he could die at home.

The greatest "bear" on Wall Street (Jesse Livermore) committed suicide.

The president of the world's greatest monopoly (Ivar Kruger) committed suicide.

The president of the Bank of International Settlements (Leon Frazer) committed suicide.



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

Bob Jensen's SPE threads are at 

Bob Jensen's threads on accounting theory are at 


Bob Jensen's main document on the Enron scandal and other accounting frauds is at 


In March 2000, Forbes named as the Best Website on the Web ---
Some top accountancy links ---


For accounting news, I prefer AccountingWeb at 


Another leading accounting site is at 


Paul Pacter maintains the best international accounting standards and news Website at

How stuff works --- 


Bob Jensen's video helpers for MS Excel, MS Access, and other helper videos are at 
Accompanying documentation can be found at and 


Professor Robert E. Jensen (Bob)
Jesse H. Jones Distinguished Professor of Business Administration
Trinity University, San Antonio, TX 78212-7200
Voice: 210-999-7347 Fax: 210-999-8134  Email: