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

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

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

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

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

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

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

Quotations

It's a change in philosophy for an agency that has spent the last couple of years chasing after wrongdoing uncovered by New York Attorney General Eliot Spitzer. Throughout the spate of corporate scandals, the SEC has been conducting investigations after the fact, levying fines on companies long after the abuse has occurred, and failing to spot questionable practices, such as mutual fund trading abuses.   Donaldson (SEC Chairman) wants to change that by taking a cue from Spitzer. Spitzer's strategy was to narrow his focus and concentrate on areas where small investors were being harmed. The SEC will do the same through a newly formed office of Risk Assessment, the Washington Post reported.
"SEC Chairman: Find Solutions Before Problems Explode," AccountingWeb, September 30, 2004 --- http://www.accountingweb.com/cgi-bin/item.cgi?id=99840 

A series of e-mails dating from the mid-1990s to 2003 show that even after KPMG was ordered by the IRS to stop pushing tax shelters considered abusive, the firm continued to promote at least a dozen new similar shelters. AccountingWeb, September2, 2004 ---  http://www.accountingweb.com/item/99690 
Bob Jensen's threads on KPMG's scandals are at http://www.trinity.edu/rjensen/fraud.htm#KPMG 

Norris said the accounting firms and the airline industry share a common struggle-never have their services been more in demand but never too has their survival been so challenged.
"Can the Big Four Save Themselves," AccounitngWeb, September 15, 2004 --- http://www.accountingweb.com/cgi-bin/item.cgi?id=99750 
The above quote refers to an article by Floyd Norris in the New York Times. (See below)

The firms generally praised the board (PCOAB) and said they were working to improve their audits. James S. Turley, the chief executive of Ernst & Young, said the board would "prove to be one of the best things that ever happened to the accounting profession."
Frank Norris, The New York Times, August 27, 2004 (See below)

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

Cyber-begging is not new, but a free web service called Dropcash has linked data from payment service PayPal with that of blogging system TypePad to make it even easier to create your own fundraising webpage - complete with progress bar.
The Guardian, September 9, 2004
Bob Jensen's threads on charity frauds are at http://www.trinity.edu/rjensen/fraudreporting.htm#CharityFrauds 

The FTC said a government-funded reward system of at least $100,000 could induce people turn in those spammers who send millions of junk e-mail.  Six-figure incentives are the only way to persuade people to disclose the identity of co-workers, friends and others they know are responsible for flooding inboxes with unsolicited pitches for prescription drugs, weight loss plans and other products, according to an agency report.
The Wall Street Journal, September 16, 2004 --- http://online.wsj.com/article/0,,SB109537444890220303,00.html?mod=technology_main_whats_news 
Don't count on six-figure rewards to stop the Nigerians offshore whose scams gross hundreds of millions of dollars.  Also don't count on the rewards being funded since large numbers of legislators who will be required to appropriate funds for the rewards are in the pockets of the direct marketing industry.  Sigh!

The accounting change also could expose another weakness: In the last four quarters, Apple earned $32 million after taxes from interest on its $4.6 billion cash horde. That's nearly twice as much as the $18.5 million in operating income it would have earned under the pending FASB rules, says Albert Meyer, principal of 2nd Opinion Research. "Is it a tech company or a credit union?" Meyer asks.  If stock options had been treated as a cost, Apple's $179 million in earnings over the last four quarters ended on Mar. 27 would have fallen 69% -- significantly more than the potential drops of under 50% for other tech companies such as Dell. Out of 86 tech companies, Apple was among the 12 with the biggest hit to estimated 2005 earnings, according to Merrill Lynch (MER ).
Alex Salkever, Business Week, July 12, 2004, Page 11 (See below)

KENNETH LAY SURRENDERED to authorities in Houston to face indictment for his role in Enron's collapse. The energy giant's former CEO was charged with being part of a wide-ranging scheme to defraud investors. 
The Wall Street Journal, July 8, 2004, July 8, 2004 --- http://online.wsj.com/article/0,,SB108928566380358408,00.html?mod=home_whats_news_us 
Bob Jensen's threads on the Andersen and Enron scandals are at http://www.trinity.edu/rjensen/FraudEnron.htm 

Does all of this add up to a convincing indictment against the market? No. Even those economists like MIT's Paul Joskow who are most convinced that illegal market manipulation played a major role in the California meltdown continue to support the introduction of (better designed) markets to the electricity sector. Other economists are of the opinion that market design ought to be left to trial and error in the context of more complete deregulation rather than to some template drafted by experts who think they can know a priori how electricity markets could best be organized.
Jerry Taylor (See below.)

Of all the lawsuits, one filed against Mr. Winnick last October in federal court in Manhattan holds special significance. J. P. Morgan Chase and other leading banks are seeking $1.7 billion in damages from Mr. Winnick and other Global Crossing executives, contending that the group engaged in a "massive scam" to "artificially inflate" the company's performance to secure desperately needed loans. Mr. Winnick, whose lawyers dispute the accusations, declined to be interviewed for this article.  Among other things, the suit refocuses attention on exactly what Mr. Winnick knew about his company's finances during times when it was borrowing heavily and he was selling hundreds of millions of dollars in stock. It also outlines a troubling series of meetings he held with Mr. Lay and other Enron executives just months before their company crumpled.
Timothy O'Brian, "A New Legal Chapter for a 90's Flameout," The New York Times, August 15, 2004 --- http://www.nytimes.com/2004/08/15/business/yourmoney/15win.html 

Bye Bye Birdie
As part of an agreement with the federal government's Pension Benefit Guaranty Corporation (PBGC), beleaguered energy giant Enron Corp. has agreed to place $321 million in an escrow account in order to fully fund four defined-benefit pension plans. The money will come from proceeds of the $2.45 billion sale of the company's U.S. pipeline business. The pipeline business is considered to be Enron's most prized remaining asset.
AccounitngWeb, September 16, 2004 --- http://www.accountingweb.com/cgi-bin/item.cgi?id=99765 
Bob Jensen's threads on the Enron/Andersen scandals are at http://www.trinity.edu/rjensen/fraudenron.htm 

n my view Global Crossings is the pinnacle of corporate management profiteering. I cannot believe that Justice did not prosecute this obvious case of fictitious earnings manipulation and Gary Winnick is left with over $735 million when investors had an 18 billion collapse.
Miklos A. Vasarhelyi, Rutgers University, August 15, 2004 email message

Try This Out for Mutual Fund Conflict of Interest:  Guess the Stance Taken by Fidelity's Board With Respect to Expensing of Corporate (read that Intel) Failure to Expense Employee Stock Options?
But while Fidelity funds hold almost 3 percent of Intel's shares for clients, Intel is also a big customer of Fidelity, creating the potential for a conflict at the fund giant. Fidelity is the recordkeeper for Intel's 401(k) plan, which held eight Fidelity funds worth $1 billion at the end of 2003.
Gretchen Morgenson, "A Door Opens The View Is Ugly Mutual Fund Board Voting," The New York Times,  September 12, 2004.
Bob Jensen's threads on the mutual fund scandals are at http://www.trinity.edu/rjensen/fraudrotten.htm#MutualFunds 

Bob Jensen's threads on why white collar crime still pays --- http://www.trinity.edu/rjensen/fraudconclusion.htm#CrimePays 

Turning to business, the board rapidly approved a series of transactions, according to the minutes and a report later commissioned by Hollinger. The board awarded a private company, controlled by Lord Black, $38 million in "management fees" as part of a move by Lord Black's team to essentially outsource the company's management to itself. It agreed to sell two profitable community newspapers to another private company controlled by Lord Black and Hollinger executives for $1 apiece. The board also gave Lord Black and his colleagues a cut of profits from a Hollinger Internet unit.  Finally, the directors gave themselves a raise. The meeting lasted about an hour and a half, according to the minutes and two directors who were present.
Robert Frank and Elena Cheney --- http://www.trinity.edu/rjensen/fraud.htm#Governance 

Bankruptcy Isn't Cheap for MCI
Lawyers, advisers and accountants who worked for MCI as it went through the biggest Chapter 11 bankruptcy case in U.S. history are seeking approval to collect about $600 million in fees, according to filings with the U.S. Bankruptcy Court for the Southern District of New York. The Ashburn, Va., telecommunications company, formerly known as WorldCom Inc., filed for bankruptcy-court protection in 2002 after an accounting fraud that ultimately totaled $11 billion. MCI emerged from Chapter 11 in April and the fees cover the entire period of the bankruptcy. Almost all the money has been paid, but the bills need final approval, according to a person familiar with the matter. MCI kept squads of lawyers from Weil, Gotshal & Manges LLP and accountants from Deloitte & Touche LLP and KPMG LLP on duty as it hurried to emerge from bankruptcy protection as soon as possible. Company officials have said that they knew fees would run into the hundreds of millions of dollars.
The Wall Street Journal, August 17, 2004 --- http://online.wsj.com/article/0,,SB109271165611793323,00.html?mod=technology%5Fmain%5Fwhats%5Fnews 

But for What Reasons?
Have accountants finally shed their dry bean-counter image? Can accounting be viewed as a "sexy" career choice? Maybe so, if the number of new accounting majors among college freshmen is any indication. Academics say the seemingly never-ending series of corporate scandals over the last few years has piqued the interest of today's students.
"Corporate Scandals Attract Students to Accounting," AccounitngWeb, August 2, 2004 --- 
 http://www.accountingweb.com/item/99558 

August 2, 2004 message from Ethical Performance [list_admin@ethicalperformance.com] 

Ford Motor Company's 2003-04 Corporate Citizenship Report - which covers a wide range of topics from the Escape Hybrid sports utility vehicle to human rights and HIV/AIDS prevention - is now available.

Organized once again around Ford's seven Business Principles, the new report provides data and a review of performance in each area.

A special section, entitled Feature Articles, examines areas where Ford believes it has made significant progress or faces particular challenges, including the Company's expanding investment in China and a look at the potential of hydrogen fuels and advanced technologies.

The report also has commentary from people inside and outside Ford on important issues such as climate change, vehicle safety and community engagement.

The full report and an opportunity for you to provide direct feedback can be viewed at http://www.ford.com/go/globalcitizenship. 

Printed hard copies of the report can be requested from mailto:corpcit@ford.com.

QWEST EX-CEO JOSEPH NACCHIO soon may face civil charges over improper accounting. The telecom firm agreed to a preliminary $250 million settlement with the SEC.
Deborah Solomon et al, The Wall Street Journal, September 13, 2004, Page A3 --- http://online.wsj.com/article/0,,SB109483441282814794,00.html?mod=technology_main_whats_news 

Iwan Lost
Qwest executives massaged a deal with the Arizona School Facilities board to book the sale early and misled auditors about their actions, former Arthur Andersen auditor Mark Iwan testified Thursday.  Iwan said Grant Graham, a former Qwest finance executive, assured him the transaction would comply with accounting standards necessary to book the $33.6 million in the second quarter of 2001.
Tom McGhee, The Denver Post, March 19, 2004 --- http://www.denverpost.com/Stories/0,1413,36%257E26430%257E2027537,00.html 

Accounting rules still allow companies to classify lease obligations differently than debt, leaving billions of dollars off corporate balance sheets and relegating a big slice of corporate financing to the shadows.
Jonathan Weil, "How Leases Play A Shadowy Role In Accounting" --- http://www.trinity.edu/rjensen//theory/00overview/theory01.htm#Leases 

At the FASB (Financial Accounting Standards Board), Bob Herz says he thinks "lease accounting is probably an area where people had good intentions way back when, but it evolved into a set of rules that can result in form-over substance accounting."  He cautions that an overhaul wouldn't be easy:  "Any attempts to change the current accounting in an area where people have built their business models around it become extremely controversial --- just like you see with stock options."
Jonathan Weil, "How Leases Play A Shadowy Role In Accounting" --- http://www.trinity.edu/rjensen//theory/00overview/theory01.htm#Leases   
By the phrase form over substance, Bob Herz is referring to the four bright line tests of requiring leases to be booked on the balance sheet.  Over the past two decades corporations have been using these tests to skate on the edge with leasing contracts that result in hundreds of billions of dollars of debt being off balance sheets.  The leasing industry has built an enormously profitable business around financing contracts that just fall under the wire of each bright line test, particularly the 90% rule that was far too lenient in the first place.  One might read Bob's statement that after the political fight in the U.S. legislature over expensing of stock options, the FASB is a bit weary and reluctant to take on the leasing industry.  I hope he did not mean this.

When the Securities and Exchange Commission found evidence in e-mail messages that a senior partner at Andersen had participated in the fraud at Waste Management, Andersen did not fire him. Instead, it put him to work revising the firm's document-retention policy. Unsurprisingly, the new policy emphasized the need to destroy documents and did not specify that should stop if an S.E.C. investigation was threatened. It was that policy David Duncan, the Andersen partner in charge of Enron audits, claimed to be following when he shredded Andersen's reputation.

Floyd Norris (see below)

Forwarded by Miklos A. Vasarhelyi from Rutgers University
"Will Big Four Audit Firms Survive in a World of Unlimited Liability?," by Floyd Norris, The New York Times, September 10, 2004 

RE the Big Four accounting firms members of an endangered species, destined to die from litigation?

Within the accounting profession there has been growing fear ever since Arthur Andersen vanished in a sea of liability that it was only a matter of time before another firm followed. And then, the thought goes, the others would find it impossible to persuade partners to stay, lest their net worth be decimated as happened at Andersen.

Perhaps the situation is not unlike the one that confronts the major airlines. Never has there been such need and demand for the service they provide, but as commercial ventures their viability is dubious at best. The difference is that there are a host of low-cost airlines willing to take up the slack if Alitalia or United should vanish, while it is not at all clear who could replace the Big Four.

The alternative of government auditors is an unattractive one. The quality of the audits would be suspect, if only because of the difficulty in attracting good auditors at government pay, and political influence could be a problem. Consider the way technology companies got the House of Representatives to oppose reasonable accounting for stock options, or the fact that the European Commission is on the verge of overruling an international accounting rule on derivative accounting after heavy lobbying by banks.

It is easier to understand how we got to the current situation than it is to figure out how to get out of it. Over time, the big accounting firms sought growth rather than excellence. Partners were rewarded for bringing in more business and penalized for offending clients with tough audits. There was no effective regulator.

When the Securities and Exchange Commission found evidence in e-mail messages that a senior partner at Andersen had participated in the fraud at Waste Management, Andersen did not fire him. Instead, it put him to work revising the firm's document-retention policy. Unsurprisingly, the new policy emphasized the need to destroy documents and did not specify that should stop if an S.E.C. investigation was threatened. It was that policy David Duncan, the Andersen partner in charge of Enron audits, claimed to be following when he shredded Andersen's reputation.

Now there are real reforms. The Public Company Accounting Oversight Board in the United States is watching over audit quality, and other countries are following suit.

The firms appear tougher. ''We are turning down clients at an unprecedented rate,'' said James H. Quigley, the chief of Deloitte & Touche's American operations, in an interview. ''We are very rigorous in terms of who we become associated with in this world of unlimited liability.''

But better audits now will not repair poor audits of the past, and the firms yearn for legal protection. In the United States, that is so unrealistic politically that no specific proposal is pending. In Britain, their plea for a cap on damage awards was rejected by the government this week.

This may be a case of Catch-22. If auditors are doing a good job, they deserve to be protected from lawsuits that could put them out of business. But without the threat of such suits, will they do a good job?

The probable outcome is that the firms will muddle through. Plaintiffs lawyers will temper their demands, knowing they need to keep the firms in business. If Big Four managements really appear to be determined to run quality firms, governments are not likely to bring criminal charges that will put them out of business, even if individual partners committed outrageous acts.

Good auditing is essential to functioning capital markets, but in too many cases in the 1990's, auditors deemed it their job to help companies find ways to twist accounting rules and mislead investors. The reforms may have arrived just in time to save the Big Four.

Bob Jensen's threads on incompetent and corrupt audits are at http://www.trinity.edu/rjensen/fraudconclusion.htm#IncompetentAudits 

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

Bob Jensen's threads on scandals in the major international CPA firms are at http://www.trinity.edu/rjensen/fraud.htm#others 

"Microsoft, Amazon Unite to Battle E-Mail Scammers," by Judy Lam, The Wall Street Journal, September 29, 2004, Page D3 --- http://online.wsj.com/article/0,,SB109639503163330213,00.html?mod=technology_main_whats_news 

Amazon.com Inc. and Microsoft Corp. have joined forces to combat online fraud and find the people behind e-mail scams that send millions of forged messages to consumers.

Yesterday, the two companies said they filed suits against Canadian company Gold Disk Canada Inc. and three individuals for allegedly sending millions of unsolicited e-mails using Microsoft's Hotmail services and forging the name of Amazon.com. The suits were filed in Superior Court of the State of Washington and the U.S. District Court in Seattle.

Amazon and Microsoft said they are working to identify offenders and are collaborating to test technical solutions that would make it more difficult to send unwanted messages to consumers.

Over the past year, Microsoft has stepped up its efforts to fight spam and e-mail scams as part of a broader move to stem a range of attacks on its software. The company has had to respond to growing customer complaints about the security of Microsoft applications, prompting the company to release a host of new security software, sign new partnerships, and begin taking more legal action to thwart hackers and senders of spam.

Continued in the article

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

Always ask your broker or investment advisor about kickbacks!
Better yet, buy into honest mutual funds directly and leave your broker out of the picture.

"SEC to Sever a Tie Linking Mutual Funds, Brokerage Firms," by Karen Damato and Deborah Solomon, The Wall Street Journal, August 10, 2004, Page C1 --- http://online.wsj.com/article/0,,SB109277224166993831,00.html?mod=home_whats_news_us 

The Securities and Exchange Commission today (August 18, 2004) is expected to ban a type of arrangement that mutual-fund companies long have used to gain favored status for their products at brokerage firms.

The agency will no longer allow fund-management companies to channel their funds' securities-trading orders and the associated commissions to brokerage firms as compensation for selling and prominently placing their fund shares, according to people familiar with the matter.

Still, the crackdown on what is known as "directed brokerage" isn't likely to alter the underlying environment in which hundreds of fund companies, all competing for "shelf space" at the brokerage firms favored by individual investors, feel obliged to pay for that access in one way or another. "If they can't pay through directed brokerage, then they will pay another way," predicts Cynthia Mayer, a fund-industry analyst at Merrill Lynch.

Regulatory scrutiny has led a number of fund managers to curtail their use of directed brokerage in recent months, and fund firms already may be making increased direct payments to brokerage firms, according to analysts including Ms. Mayer and her Merrill colleague Guy Moszkowski.

SEC officials, who declined to speak publicly because of today's vote, acknowledge that banning directed brokerage might lead to an increase in direct payments, known as "revenue sharing." But they say direct payments are preferable because they come from the fund adviser's pocket and not from assets owned by fund shareholders.

Properly disclosed revenue-sharing arrangements "present more manageable conflicts" for funds and brokerage firms than directed-brokerage deals, the SEC said in proposing the ban in February.

At the same time, the agency is investigating whether a number of fund companies are adequately disclosing these payments, which can include sponsoring seminars or other events for brokers, and fund-company executives privately complain that the rules on this practice are in flux as well.

It is legal for fund companies to consider the level of fund-share sales at a brokerage firm in allocating their trades as long as that consideration is disclosed to fund investors and the investors aren't disadvantaged.

Continued in the article

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

"Deloitte & Touche Launches DTect Financial Fraud Investigation Service," SmartPros, September 7, 2004 --- http://www.smartpros.com/x45061.xml 

The Financial Advisory Services practice of Deloitte & Touche LLP has launched DTect, a proprietary fraud investigation service designed to help companies identify, track and analyze electronic and financial fraud indicators by sifting through large amounts of electronic data in a fraction of the time expended by using existing conventional methods.

“We involved forensic technology practitioners and forensic accountants from around the world in the development of the service. Many of these professionals are former law enforcement technologists with significant experience in the use of computers in economic crime investigations,” said Peter McLaughlin, DTect National Product Line Leader.

DTect is a procedural-driven service created to analyze mountains of historical financial transactional data such as sales, accounts payable, inventories and employee compensation. It is designed to utilize hundreds of analytical test algorithms, resulting in profiles that help identify anomalies that could indicate financial fraud. These test algorithms are executed against client-supplied data, which result in a series of profiles that are scored and ranked according to client-specific risk measurements. The higher ranking scores indicate the most probable occurrences of potential fraud, abuse, or collusion of employees and vendors.

The DTect service does not rely solely on traditional sampling techniques but enables comprehensive testing of multiple aspects of financial transactions. Anomalies and trends are identified through DTect’s unique scoring methodology, which is used to focus efforts on the highest risk transactions and entities. Other differentiators that set DTect apart from traditional software technology include the incorporation of third-party data sources, analysis of the total population of records rather than only a sampling and the ability to customize test scenarios to conform to specific client needs.

In developing DTect, Deloitte & Touche forensic professionals analyzed all types of fraud to identify distinguishing attributes. The investigators then created the tests, which can be applied to business processes such as vendor, payroll and expense disbursements, to detect the presence of fraud characteristics. Each test generates a risk score, which is assigned to each vendor, employee or job category, invoice, or transaction that fails a test. High risk scores indicate anomalies in vendors and transactions. Deloitte & Touche investigators then work with their clients to interpret and explain results, to investigate and resolve anomalies, and to identify potential incidents of fraud.

Continued in the article

Bob Jensen's threads on new assurance services are at http://www.trinity.edu/rjensen/fraudconclusion.htm#AssurnaceServices 

Fannie Mae's regulator is set to present a report highly critical of the mortgage company's accounting practices to its board: Probe points to decisions to smooth out earnings, possibly increase bonuses

Bob Jensen's threads about fraudulent accounting at Freddie Mac and Fannie Mae are at http://www.trinity.edu/rjensen/caseans/000index.htm 

The Justice Department opened a probe of possible accounting fraud at Fannie Mae. The move comes in the wake of a report by Fannie's regulator that the mortgage company may have manipulated its books to meet earnings targets.
"Fannie Criminal Probe Is Launched," by John R. Wilke et al, The Wall Street Journal, September 29, 2004 --- http://online.wsj.com/article/0,,SB109649594924831762,00.html?mod=home_whats_news_us 

"Fannie Mae Overseer to Present Report Criticizing Accounting," by John D. McKinnon and James R. Hagerty, The Wall Street Journal, September 20, 2004, Page A2 --- http://online.wsj.com/article/0,,SB109563119263921750,00.html?mod=home_whats_news_us 

Federal regulators are to present a report highly critical of accounting practices at Fannie Mae to the mortgage company's board today, according to several people familiar with the situation.

The company's regulator, the Office of Federal Housing Enterprise Oversight, or Ofheo, declined to comment on the status of the eight-month probe of Fannie's accounting. But people who have been briefed on the results said Ofheo found evidence of a pattern of decisions by executives aimed at manipulating earnings to present a smoother performance. Ofheo also has been examining whether the decisions were made with an eye to beefing up bonuses to executives, they added.

Fannie's corporate cousin, Freddie Mac, agreed to pay a $125 million civil penalty for using a series of exotic financial transactions and other accounting gimmicks to smooth its earnings. A finding that Fannie Mae also manipulated its financial reports to make them look less volatile could boost efforts in Congress to tighten regulation of the two federally chartered mortgage companies.

"The smoothing problem at Freddie Mac has been determined to be present at Fannie Mae,'' said Rep. Richard Baker (R., La.), chairman of the House subcommittee that oversees government-sponsored enterprises such as Fannie and Freddie. Mr. Baker was briefed on the situation by congressional staff. He said that while the Ofheo examination continues, he believes regulators are exploring whether one

reason for the smoothing was to maximize some executives' compensation.

Stepping up the pressure on Fannie, Ofheo brought in as an adviser Washington lawyer Stanley Sporkin, a former federal judge and onetime enforcement director at the Securities and Exchange Commission. Mr. Sporkin took part last week when Ofheo presented its findings to the SEC, which also regulates Fannie, people familiar with the situation said.

By engaging such a high-powered securities lawyer, Ofheo seems determined to block Fannie from driving a wedge between it and the SEC over interpretations of accounting rules. Fannie is being advised by Wilmer Cutler Pickering Hale and Dorr LLP, known for its securities-law expertise and close contacts at the SEC.

A Fannie Mae spokesman declined to comment, as did an SEC spokesman. A spokesman for KPMG LLP, Fannie's outside auditor, said that the firm hasn't seen the Ofheo findings but that "we stand behind our audit work for Fannie Mae." Mr. Sporkin, a partner at the law firm Weil, Gotshal & Manges, couldn't be reached.

Fannie's chief executive officer, Franklin D. Raines, repeatedly has defended the company's accounting.

Ofheo announced the examination into Fannie's accounting last year following the scandal at Freddie Mac. Freddie ousted two CEOs and other senior executives in the course of that investigation. Ofheo eventually found the company had manipulated its accounting to make earnings look less volatile; steadily rising earnings are important to the companies' shareholders and debtholders, who seek reassurance that Fannie and Freddie can withstand fluctuations in interest rates and the real-estate market.

Freddie later disclosed that its accounting misdeeds led it to understate earnings by about $5 billion over several years. Investors were relieved to find that Freddie was even more profitable than it had appeared.

Continued in article

"Regulator Details a Wide Range Of Accounting Problems at Fannie," by James R. Hagerty et al, The Wall Street Journal, September 23, 2004, Page A1 --- http://online.wsj.com/article/0,,SB109585616894724782,00.html?mod=home_whats_news_us 

Fannie Mae's regulator accused the mortgage-finance giant of a wide range of improper accounting practices -- including at least one instance in which executives allegedly delayed expenses in an apparent effort to hit their bonus targets.

In a 200-page report released late yesterday afternoon, the regulator, the Office of Federal Housing Enterprise Oversight, or Ofheo, said its findings "raise concerns regarding the validity of previously reported financial results, the adequacy of regulatory capital, the quality of management supervision and the overall safety and soundness" of the company.

. . . 

Ofheo's interim report on its continuing examination also accuses Fannie of:

• Applying accounting methods and practices that don't comply with generally accepted accounting principles, or GAAP, to the company's derivatives transactions and hedging.
 
• Using a "cookie jar" reserve. Such reserves are used to improperly delay recognizing income so that it can be used to enhance results in later periods.
 
• Tolerating what it called "internal control deficiencies."
 
• Maintaining "a corporate culture that emphasized stable earnings at the expense of accurate financial disclosures."
 

Fannie's chief spokesman, Chuck Greener, declined to comment on whether the management agreed with any of the allegations but said the company's board is working with Ofheo "to resolve the issues." In a statement, the company promised to report back to Ofheo and the SEC "expeditiously" and said that the board has set up a committee composed entirely of outside directors "to take the lead on both the Ofheo report and the SEC inquiry." The statement was issued under the name of Ann McLaughlin Korologos, the presiding outside director.

Bob Jensen's threads about fraudulent accounting at Freddie Mac and Fannie Mae are at http://www.trinity.edu/rjensen/caseans/000index.htm 

"Google queries provide stolen credit cards," by Robert Lemos, CNET News,  August 3, 2004 --- http://news.com.com/Google+queries+provide+stolen+credit+cards/2100-1029_3-5295661.html?tag=nefd.lede 

Simple queries using the Google search engine can turn up a handful of sites that have posted credit card information to the Web, CNET News.com learned on Tuesday.

The lists of financial information include hundreds of card holders' names, addresses and phone numbers as well as their credit card data. Much of the credit card data that appears in the lists found by Google may no longer be valid, but News.com called several people listed and verified that the credit card numbers were authentic. The query, the latest example of "Google hacking," highlights increasing concern that knowledgeable Web surfers can turn up sensitive information by mining the world's best-known search engine.

"It seems like everyone has their own trick," said Chris Wysopal, vice president of research and development for digital security firm @Stake. "This is really searching for data that should be secret but has been exposed either through misconfiguration or by someone who has stolen it."

There is no shortage of ways to search Google to find such data. Whole sites spell out how to search for financial information and describe software vulnerabilities and vulnerable configurations on Internet machines. Google is the tool of choice because its powerful search options, such as the ability to search for a range of numbers--useful in finding credit card data--is not present in other companies' search engines.

Google would not comment, citing the quiet period before the company's initial public offering. However, a company source did say that the search firm has a tool for Web masters to remove pages from the archive, if they find that parts of their site violate laws or regulations. Moreover, the company has decided to allow anyone to request the removal from search results of any document that includes a Social Security or credit card number--a note to help@google.com  with a link to the page will suffice, the source said.

Continued in the article

In 2003, occupational fraud is estimated at $660 billion.

2004 Report to the Nation on Occupational Fraud and Abuse, The Association of Certified Fraud Examiners --- http://www.cfenet.com/resources/rttn.asp 

Occupational fraud and abuse is a widespread problem that affects every entity, regardless of size, location or industry. The ACFE has made it a goal to better educate the public and anti-fraud professionals about this threat. The 2004 Report to the Nation is based on a survey that began in late 2003 and ran through the early months of 2004. Certified Fraud Examiners throughout the US were asked to provide detailed information on one fraud case he or she had personally investigated that met the following criteria: The case involved occupational fraud; The fraud occurred within the last two years; The investigation of the fraud was complete; and The CFE was reasonably sure that the perpetrator had been identified.

The end result is a comprehensive report that sheds light on occupational fraud and abuse while offering stark lessons and valuable insights about its prevention and detection.

Download the 2004 Report to the Nation * (564 kb)
Order a printed copy of the 2004 Report to the Nation
Download the 2002 Report to the Nation * (857 kb)
Download the 1996 Report to the Nation * (235 kb)

"PwC: Accounting Irregularities Cause Most Class-Action Settlements," SmartPros, August 4, 2004 --- http://www.smartpros.com/x44644.xml 

The number of securities litigation cases with accounting allegations remains well above historical averages, according to a PricewaterhouseCoopers Securities Litigation Study and a preliminary analysis of the first six months of 2004.

Mega-settlements continue to drive average settlement values significantly higher than ever before. The involvement of the Department of Justice (DOJ) and Securities and Exchange Commission (SEC) adds additional potency to the nature of securities litigation.

Accounting-Related Cases

The number of accounting-related cases remains high, totaling more than 60 percent of the 175 cases filed in 2003 and 57 percent of the 111 cases filed in the first seven months of 2004.

The number one allegation made in accounting-related cases continues to be revenue recognition, alleged in over fifty percent of these cases in 2003.

The study also finds two other allegations that are emerging in accounting-related cases: accounting estimates and internal controls. In 2003 each of these allegations appeared in over 40 percent of the accounting cases.

Settlement Values Continue to Rise

In 2003, average settlement values increased by 20 percent to $23.2 million. The increase was fueled in large part by six settlements topping $100 million each, including three settlements of $300 million or greater, with one of those settlements topping $500 million.

Excluding several partial settlements, including the recent $2.65 billion partial Worldcom settlement, the average settlement in the first six months of 2004 surged to over $32 million. So far in 2004, 14 settlements have been announced for $30 million or greater, five of which settled for $100 million or more. The average accounting case, led by five case settlements over $100 million each, settled for over $38 million. While large settlements continue to lift settlement averages to new heights, the median 2004 settlement is approximately $6.3 million and the median accounting settlement is greater than $7 million, both up from the 2003 numbers.

Triple Jeopardy Increases Potency of Cases

The dynamic of securities litigation has changed dramatically in securities litigation class actions when the SEC and DOJ are also involved.

This year for the first time, PricewaterhouseCoopers explored a phenomenon called "triple jeopardy," where companies are subject to securities class actions along with SEC and DOJ investigations. In 2002, there were an all-time high of over 40 such cases. In 2003 the study finds only 8 such instances which marks a return closer to historic norms. The preliminary 2004 research indicates that at least 13 companies are facing "triple jeopardy" this year, already surpassing the 2003 total.

"The fines and penalties meted out in recent SEC and DOJ settlements with companies also facing securities litigation have risen dramatically, and criminal prosecutions and convictions for corporate fraud offenses are ratcheting up," said Charles Hacker, Investigations and Forensic Services partner, PricewaterhouseCoopers.

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

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

From The Wall Street Journal's Accounting Weekly Review on September 17, 2004

TITLE: Letters to the Editor: Protecting Shareholders Is No "Shenanigan" 
REPORTERS: Reeves, William T., Jr. and Nicholas Maiale 
DATE: Sep 10, 2004 
PAGE: A13 
LINK: http://online.wsj.com/article/0,,SB109478214704214479,00.html  
TOPICS: Accounting, Board of Directors, Corporate Governance, Dividends, Shareholder Class-Action Lawsuit

SUMMARY: Representatives of two institutional investors respond to a WSJ opinion piece on litigation against companies in which they invest. For a summary of the 1995 Securities Litigation Reform Act and related research, one good resource is a Stanford Law School web page http://securities.stanford.edu/research/studies/19970227firstyr_firstyr.html 

QUESTIONS: 
1.) In general, why would institutional investors such as the Teachers' Retirement System of Louisiana (TRSL) undertake litigation against the companies in which they invest?

2.) What recent events make it particularly likely that, at this point in time, institutional investors will undertake litigation against the companies in which they invest?

3.) How can this litigation contribute to improved corporate governance? How might it detract from good governance? In your answer, define the term "corporate governance."

4.) Refer to the related article. In regards to two funds representing Pennsylvania public school teachers and state employees suing Time Warner and Royal Dutch/Shell, the author writes that "shareholders are essentially suing themselves" and, therefore, "the main winners will be the lawyers." Why does the author argue that shareholders suing a company are "suing themselves"? Explain this statement in terms of the balance sheet equation. Also, explain in detail your understanding of potential wealth impacts of the lawsuit on all company shareholders.

5.) The Teachers' Retirement System of Louisiana (TRSL) brought one legal action to stop a particular dividend payment. Why did this institutional investor want to stop this dividend payment? How are dividends typically funded? Are there any legal requirements for funding dividend payments? Cite examples and describe the source of these laws.

6.) Summarize the political tones of these letters to the editor and contrast with the political tone of the related article (the WSJ Opinion piece). How do these political perspectives influence the opinions expressed in the articles? In your discussion, also reference the political parties discussed in detail in the article.

Reviewed By: Judy Beckman, University of Rhode Island

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

"Big Four Get Mixed Marks From U.S. Accounting Panel," by Jonathan Weil, The Wall Street Journal, August 27, 2004 , Page C1 --- http://online.wsj.com/article/0,,SB109353829914301998,00.html?mod=home_whats_news_us 

KPMG LLP said the accounting profession's federally created overseer found the firm had accepted fees from independent-audit clients based on how much money it helped them save in taxes -- a possible violation of conflict-of-interest rules that remain a major priority in the aftermath of Enron Corp.'s collapse and other corporate scandals.

That finding is included in a part of the U.S. Public Company Accounting Oversight Board's first set of annual reports on the nation's four biggest accounting firms that, under a law the Big Four firms successfully lobbied for, remains secret.

The public portions of the reports, released yesterday, identify "significant audit and accounting issues that were missed by the firms," the board said, though none of those problems caused major shareholder losses and almost none of them affected earnings.

KPMG's decision to voluntarily disclose the finding of potentially significant conflicts highlights how shrouded in secrecy the new agency's process will be. The other three firms -- PricewaterhouseCoopers LLP, Deloitte & Touche LLP and Ernst & Young LLP -- declined to specify what concerns, if any, the board raised about them in the confidential sections of their reports. In addition to findings on their compliance with auditor-independence rules, the confidential sections include critiques of the firms' risk-management practices, partner-compensation structures and disciplinary policies. Other key areas include the board's assessments of the firms' internal inspection programs and the "tone at the top" set by the firms' top executives.

In a written summary of the board's confidential findings provided by KPMG, the firm said the board had observed that its "contingent fee" arrangements "may not be consistent with the SEC's independence requirements." In a statement yesterday, KPMG's chairman and chief executive, Eugene O'Kelly, said the firm remains "confident that KPMG's system of quality control is sound and that none of the PCAOB's comments from their limited inspection represent systemic issues. Rather, we view their observations as opportunities for improvement, which we are committed to implement."

Mr. O'Kelly called the inspection process "an important part of the effort to enhance the integrity and transparency of financial reporting ... and improve the quality of audits."

KPMG said it began revising its contingent-fee policies, under which clients are charged based on a percentage of the money their accountants can save them, in May 2004 after the Securities and Exchange Commission's chief accountant issued a letter clarifying the agency's rules on the issue. KPMG said it is in the process of restructuring or settling any remaining contingent-fee arrangements and that it has initiated "discussions with audit committees about our independence relative to these arrangements." Under SEC rules, auditors are barred from entering such fee arrangements with audit clients, out of concern that they create mutual financial interests.

KPMG said, before the SEC's May letter, it had been relying on an American Institute of Certified Public Accountants interpretation of the SEC's rules, under which it thought such fee arrangements would be allowed when selling certain tax services to audit clients. In its letter, the SEC debunked the AICPA's theory.

Yesterday's reports by the accounting board, which was created by Congress in 2002 under the landmark Sarbanes-Oxley securities-overhaul legislation, mark the first time that auditors of publicly held companies have submitted to public evaluations by an independent authority. While the board's initial round of inspections was limited in scope, the fact that the reports contained any criticisms at all marks an improvement over the firms' prior system of "peer review." Under that approach, at a time when the auditing profession still was allowed to regulate itself, the major accounting firms reviewed each other every few years and refrained from criticisms.

While the reports do include lengthy citations of audit and accounting issues that all the firms missed, it will be at least another year before the public can learn from the board itself about any broader, structural deficiencies at the firms. When Congress created the board, it acceded to pressure by the Big Four firms to include a provision in the law under which the board only would disclose the existence of deficiencies in a firm's quality controls if the firm hadn't fixed them within a year.

"Unfortunately, we don't know how many more infractions were not made public as a result of Congress allowing those to remain behind closed doors," says Lynn Turner, the SEC's chief accountant from 1998 to 2001. "Congress needs to quickly bring that out into the sunshine."

The accounting firms contend that the best way to improve audit quality is through a confidential process. Spokesmen for PricewaterhouseCoopers, Ernst & Young and Deloitte declined to discuss the confidential sections of their reports. "We don't intend to depart from the process set forth by Congress, which focuses on remedial action to improve audit quality," said Steve Silber, a PricewaterhouseCoopers spokesman.

One promising development described in the public sections of the firms' reports was the inspectors' success at identifying a type of accounting violation that all four firms had failed to catch. After noticing that a client at one firm improperly had classified a certain kind of short-term debt as long-term debt, the board then asked all four firms to check other clients for the same problem. In the end, at least 20 companies had to restate their balance sheets, though the restatements didn't affect their earnings, cash flow or shareholder equity. Of those, six were KPMG clients, while eight were Deloitte clients. PricewaterhouseCoopers and Ernst each had three.

The board didn't identify the companies. A search of SEC filings turned up nearly two dozen companies, including some audited by other accounting firms, that had restated their financial reports this year because of the same issue, which centers on a 1995 rule by the Financial Accounting Standards Board's Emerging Issues Task Force. Those companies, all fairly small, included Restoration Hardware Inc., AEP Industries Inc. and Pemstar Inc. All these companies cited the need to comply with the 1995 ruling in explaining their restatements.

The board's inspections, which took place last year, were limited to 16 audits at each of the Big Four firms. The board's second round of inspections, now in progress, will expand beyond the Big Four and cover dozens of audits at each of the major accounting firms.

Without admitting fault, KPMG LLP settled a suit connected to the collapse of General American Life Insurance Co., formerly Missouri's largest insurance company. In a settlement approved last week, KPMG will pay $18 million to a General American liquidation fund. 
AccountingWeb, September 29, 2004 --- http://www.accountingweb.com/item/99836 

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

"Federal Regulators Find Problems at 4 Big Auditors," by Floyd Norris, The New York Times, August 27, 2004

The new regulatory body for the United States auditing industry said yesterday that its initial inspections of the Big Four accounting firms had found "significant audit and accounting issues" in work done by all four firms.

It added that it had found problems in the quality control systems at each firm but said it retained confidence in all of them.

Inspection reports on the four firms were released by the Public Company Accounting Oversight Board, which was established by Congress in 2002 in the wake of the failures of Enron and WorldCom and the collapse of Arthur Andersen, the auditing firm that had certified the books at both companies.

The board reviewed the details of 16 audits in 2003 at each firm. The versions of the reports that were made public left out large parts of the actual reports because Congress ordered that the firms be given a year to clean up many problems before negative assessments could be made public.

William J. McDonough, the board's chairman, tried to soften the blow on the firms by saying the "criticisms do not reflect any broad negative assessment of the firms' audit practices" and emphasizing that "our findings say more about the benefits of the robust, independent inspection process envisioned in the Sarbanes-Oxley Act of 2002 than they do about any infirmities in these firms' audit practices."

He added that "none of our findings has shaken our belief that these firms are capable of the highest quality auditing."

Nonetheless, the reports document cases where the four firms failed to apply one accounting rule, leading companies to understate the amount of their current liabilities - debts due within one year - and therefore overstate their working capital, an item that analysts often follow.

That rule was issued in 1995 by the Emerging Issues Task Force, a part of the Financial Accounting Standards Board, and the fact that all of the top firms had been misapplying it raised issues of just how well they know the sometimes complicated rules.

At Deloitte & Touche, the board said eight clients had restated their financial statements because of the error on the accounting rule. It said six clients of KPMG, three of Ernst & Young and three of PricewaterhouseCoopers had done the same.

Some of the errors were found by the standards board, and others by the firms.

The board also criticized Deloitte for signing agreements with one unidentified audit client that created close business relationships that seemed to violate Deloitte's own rules. It said the firm had concluded the contracts "included inappropriate language" but had not violated independence rules. Board officials said that most comments on independence issues were contained on the parts of the reports not made public.

KPMG released some information on the part of its report that was not made public, saying the standards board had concluded that some contingent fee arrangements with audit clients violated independence rules. The firm said that it had complied with the rules as it understood them but had learned in May that the S.E.C. was taking a more restrictive stance. It said it had changed agreements to comply with that interpretation and that its independence had not been compromised.

Applying accounting rules can be difficult, and in a number of other cases the staff disagreed with the way the auditing firms had applied the rules and companies ended up restating their financial statements. In one case, however, the board concluded that a client of KPMG had recorded a liability improperly, but KPMG disagreed and the staff of the Securities and Exchange Commission agreed with the accounting firm, although in the end it did force a change in the amount of the liability, according to the report.

In its response to the report, KPMG said that it showed that "three knowledgeable informed bodies" - the firm, the board and the commission - had reached three different conclusions on proper accounting, "illustrating the complex accounting issues registrants, auditors and regulators all face."

The delay on releasing some negative parts of reports has been controversial, Mr. McDonough said, but he added that he thought it was a good idea. "When it comes to quality control, any negative comments we make the firms have 12 months to correct. If they correct them, they remain confidential forever." Mr. McDonough said the delay "makes sense" because it encourages firms to improve promptly.

The firms generally praised the board and said they were working to improve their audits. James S. Turley, the chief executive of Ernst & Young, said the board would "prove to be one of the best things that ever happened to the accounting profession."

August 28, 2004 reply from David Albrecht  

The PCAOB and the American Big Four don't think the recent report is bad news. However, the Times in London has a far different take..

 David Albrecht
Bowling Green State University

August 28, 2004 reply from Dennis Beresford (University of Georgia)

All of the reports are available at the PCAOB web site. In each report, the first 15 pages or so is pretty much the same, just describing the procedures that the PCAOB staff members performed at the firm. However, the "meat" is in the remainder of each report (including the firm's response to the issues raised by the PCAOB) and they are well worth reading.

While D&T had more "errors" with respect to EITF issue 95-22, my reading of the reports would conclude that they were otherwise the least criticized by the PCAOB. And when there are so many reported problems with an accounting standard like 95-22, that may be an indication that the standard isn't working very well.

The specific matters criticized by the PCAOB were almost all judged to be immaterial and not affecting the audited financial statements. And in at least a few cases there were differences of opinion as to whether the PCAOB was even correct in its position.

On the other hand, these reports were based on looking at only 16 engagements for each firm. It will certainly be interesting to see what happens next year when the PCAOB reports the results of its first comprehensive reviews of the Big 4 firms as well as a sample of other firms.

I think these reports are very valuable information for accounting educators. They point out areas where auditors may need further schooling - both in applying accounting rules and in applying auditing standards. Rather than forming impressions based on newspaper accounts, there is a wonderful opportunity here to become much more informed about what really goes on in the auditing profession. It's certainly not perfect but few human activities are. My impression is that the firms are taking this extremely seriously and the quality of audits will be even better in the future.

Denny Beresford

"Investor Scam; Con Artists Snaring Victims Across the Country," AccountingWeb, August 20, 2004 --- http://www.accountingweb.com/cgi-bin/item.cgi?id=99658 

The Securities and Exchange Commission (SEC) this week issued an investor alert designed to warn Americans about a new scam sweeping the country-answering machine "wrong number" stock touts.

Voice mail messages are appearing on home answering machines from coast to coast saying that the stock price of certain small, thinly traded companies will soon shoot up. The breezy, intimate messages sound as if a female caller mistakenly believes she has dialed a girlfriend and is confiding inside information she has learned from "that hot stock exchange guy I'm dating."

Regulators believe these voice mails are part of a "pump and dump" stock manipulation scheme, whereby the people behind the messages intend to profit by driving up the price of their targeted stocks, then selling, and leaving victims with losses. The SEC has received hundreds of complaints from investors across the country about these misdirected voice mails in recent days.

"Investors should never buy stocks on the basis of ‘hot’ tips from strangers," said SEC Investor Education Director Susan Wyderko. "We are concerned because the stock prices of companies mentioned in these calls have gone up, presumably as people listen to the messages and buy. But in all 'pump and dump' schemes, as soon as the promoter stops touting a stock, the price plummets and other investors lose their money."

The SEC is asking investors who receive these kinds of calls to let them know the company being touted, the exact date and time the call was received, the number called, and the number from which the call was made, if available. E-mail the information to Enforcement@sec.gov, or call the SEC at 1-800-SEC-0330.

Your Government at Work

"Tech Company Settled Tax Case Without an Audit," by David Cay Johnston,  The New York Times, August 10, 2004

Remy Welling is a senior auditor for the Internal Revenue Service with 22 years' experience. But when she was handed the file on a company suspected of underpaying its taxes, it contained something she had never seen before in such a case: an agreement to close the audit before it had even begun.

Instead of being given tax returns to examine, Ms. Welling was asked to sign off on a secret deal worked out by other officials at the I.R.S. The deal, she ultimately calculated, would allow a Silicon Valley company and its top executives to escape at least $51 million in additional taxes that she was convinced they should have paid.

Moreover, the agreement required the I.R.S. to cooperate with the company, a relatively small semiconductor maker named Micrel, in keeping its shareholders uninformed on some basic terms of its stock-option plan, which Ms. Welling said enriched the four top executives by as much as $20 million in total.

For I.R.S. agents, nothing is more sacred than the privacy of a tax return. Revealing information about an audit can open an agent to criminal prosecution.

But Ms. Welling has decided to discuss what happened to her in this case, she said in an interview, because she believes that it represents a particularly striking example of how outside influence and internal obsequiousness is corrupting the integrity of the tax system.

She is willing to risk going to jail, Ms. Welling said, to bring the issue to public attention.

"Someone has to tell the public about what is going on inside the I.R.S.,'' Ms. Welling said, adding that she is about to be fired for going outside the agency by taking her complaint to the F.B.I. and the Securities and Exchange Commission.

I.R.S. officials, citing privacy concerns, declined to discuss any aspects of Ms. Welling's case or the agreement with Micrel Inc. of San Jose, Calif., which had revenue last year of $241 million.

But their handling of the case suggests that they believe that Ms. Welling has overreacted. And they insist that I.R.S. procedures have been