Scandal Updates on
Bob Jensen at Trinity University
Bob Jensen's main document on the Enron scandal and other accounting frauds is at http://www.trinity.edu/rjensen/fraud.htm
It's beginning to look
more like reform as usual in
Bowing to pressure from the Big 4 CPA firms and from some large corporations, Harvey Pitt (Chairman of the Securities and Exchange Commission) bows to pressure to appoint an oversight chairman who is less likely to induce major reforms in auditing practices.
Harvey Pitt withdrew his
earlier support for John H.
Biggs, chairman of the
teachers' pension fund
TIAA-CREF, to chair the new
accounting oversight board
being created as a results
of the Sarbanes-Oxley bill. http://www.accountingweb.com/item/92584
Mr. Pitt was not initially aware that the big firms were so opposed to John Biggs.
From CFO.com --- http://www.cfo.com/specialreport/0,,344,00.html
A Good Year for Outsiders
Coming: Auditor Cataclysm?
Sussing Out The Second Six
Internal Auditors: More Power To 'Em
Auditing's New Rules of Engagement
The Fear of All Sums
Study: Auditors Don't Uncover Problems
There's a Monster in Finance
A CFO Blacklist?
Is Auditor Rotation Coming?
Suing Auditors after Bum Deals
Andersen, Justice: No Deal
Clients Give Auditors a Low Grade
Andersen's Woes: The Winners
Industry watchers are predicting a massive shake-out in the accounting business over the next few years. This may not be great news for CFOs.
by Joseph Radigan, CFO.com, October 2, 2002 --- http://www.cfo.com/article/1,5309,7802||S||344,00.html
In the wake of the year's many accounting scandals, CFOs at some publicly traded companies have been seeking auditors from outside the shrinking ranks of the top-tier accounting firms. But finance chiefs may soon find that the ranks of non-Big Four firms is thinning as well -- thanks to the very reforms that are supposed to restore confidence in the auditing profession.
Lee Graul, director of the SEC practice for BDO Seidman in Chicago, says he attended an American Institute of Certified Public Accountants (AICPA) meeting in early August where the participants concluded that their ranks would contract by as much as two thirds in the next few years. Such a consolidation would bring the number of members in the AICPA's SEC Practice Section from 1,200 to around 400.
Graul says the sentiment at the group's August meeting was that the cost of insurance and regulatory compliance will prove too great for the bulk of these audit firms. "The expectation is that the Public Company Accounting Review Board will be much more aggressive than the SEC has been in regulating auditors," Graul says. "You will see firms drummed out of the business."
Even accountancies that don't run afoul of the new oversight board (created by the Sarbanes-Oxley bill) won't want to bother with the heightened cost of compliance. Asserts Graul: "They won't want the cost of insurance."
Observers say auditing firms have yet to feel the true impact of the new wave of accounting laws and regulations. But according to Ray Ball, an accounting professor with the Graduate School of Business at the University of Chicago, complying with the new industry requirements has "raised the cost of being in business."
Ball says that auditors will "need an internal staff to ensure compliance, the cost of which will not be totally proportional to the number of clients a firm has." Small accountancies that can't distribute their fixed costs across a long list of customers will see per-client expenses go up dramatically. Big Four firms, on the other hand, should be able to parse the increased costs over their huge roster of multinational corporates.
"The smaller firms will either drop out of serving public clients or they will merge into larger companies who will incur the costs," Ball predicts.
Regional firms will likely find themselves squeezed on another front as well. The economic downturn could drive a host of smaller, entrepreneur-driven companies out of business. And those are exactly the type of clients that second-tier and regional accountancies cater to.
"Quite honestly, the degree of regulation has really caught people by surprise," notes Dana Hermanson, professor of accounting and director of research at the Corporate Governance Center for Kennesaw State University's Michael J. Coles College of Business (in Kennesaw, Georgia). "This has all been in just the last three months."
Raise High The Roof Beam, Auditor
None of this is real great news for CFOs, who work more closely with independent auditors than any other officer in the executive suite. Hermanson expects that 2003 and 2004 will be a period of tremendous turmoil as many auditors -- and clients -- grasp the impact of the new regulatory regime.
One smallish change: the cost of audits will go through the roof. "Audits may cost 40 percent more in 2002 than they did in 2001," Hermanson forecasts.
That very large spike in the cost of filing audited annual and quarterly reports may convince managers at small, privately owned companies to avoid the public markets entirely. Likewise, it might sway executives at some small-cap public companies to take their businesses private.
The dustup in the audit industry itself will be equally dramatic --particularly for smaller accounting partnerships. Says Hermanson: "You'll see some firms from the audit side that may conclude, 'Hey, we only have two audit clients. Let's get out of the business.'" Some of those firms may simply resort to providing ancillary accounting services, tax work, and compensation and benefits consulting.
In addition to a pending spike in overhead costs and shrinkage in the number of clients, some of the procedural changes under the Sarbanes-Oxley Act will also take their toll. Charles Elson, director of the Center for Corporate Governance at the University of Delaware, notes that "the rotation of partners required under Sarbanes-Oxley is going to force some consolidation."
Continued at http://www.cfo.com/article/1,5309,7802||S||344,00.html
"Smart Stops on the Web," Journal of Accountancy, October 2002, Page 23 --- http://www.aicpa.org/pubs/jofa/oct2002/news_web.htm
“Accountability, Integrity, Reliability” --- www.gao.gov
The GAO home page offers the profession a lengthy list of downloadable resources including the report, “FDIC Information Security: Improvements Made But Weaknesses Remain,” and publications on accounting and financial management. Visitors to the site can access FraudNET to “facilitate reporting of allegations of fraud, waste, abuse, or mismanagement of federal funds.”
Bob Jensen's threads on fraud are at http://www.trinity.edu/rjensen/fraud.htm
Linda Specht at Trinity University forwarded this ethics Website that may be of considerable interest --- http://www.ethicsweb.ca/codes/
Accounting for Employee Stock Options
FASB Exposure Draft on Employee Stock Options --- http://www.fei.org/download/FASB10_2.pdf
FASB Issues Exposure Draft on Accounting for Stock Options,
Amends Transition and Disclosure Provisions Norwalk, CT,
October 4, 2002
The FASB has issued an Exposure Draft, Accounting for Stock-Based Compensation—Transition and Disclosure, that would amend FASB Statement No. 123, Accounting for Stock-Based Compensation. The purpose of the proposed amendment is twofold:
•To enable companies that choose to adopt the preferable fair value based method to report the full effect of employee stock options in their financial statements immediately upon adoption.
•To make available to investors better and more frequent disclosure about the cost of employee stock options.
The proposed changes would provide three methods of transition for companies that voluntarily adopt the fair value method of recording expenses relating to employee stock options. In addition, the FASB proposes clearer and more prominent disclosures about the cost of stock-based employee compensation and an increase in the frequency of those disclosures to include publication in quarterly financial statements. Currently, companies are not required to present stock option disclosures in interim financial statements.
The FASB plans to issue the amendment to Statement 123 by the end of this year and its provisions would be effective immediately upon issuance. The proposed disclosures to be provided in annual financial statements would be required for fiscal years ending after December 15, 2002. The proposed disclosures to be provided in interim financial information would be required as of the first interim period of the first fiscal year beginning after December 15, 2002, with earlier application encouraged.
A copy of the Exposure Draft is available on the FASB’s website at www.fasb.org . The comment period concludes on November 4, 2002.
FASB News Release on October 1, 2002
NEWS RELEASE 10/01/02
FASB Issues Statement No. 147, Acquisitions of Certain Financial Institutions
Norwalk, CT, October 1, 2002—Today the FASB issued FASB Statement No. 147, Acquisitions of Certain Financial Institutions. That Statement, which provides guidance on the accounting for the acquisition of a financial institution, applies to all acquisitions except those between two or more mutual enterprises (the Board has a separate project on its agenda that will provide guidance on the accounting for transactions between mutual enterprises).
The provisions of Statement 147 reflect the following important conclusions reached by the Board:
- The excess of the fair value of liabilities assumed over the fair value of tangible and identifiable intangible assets acquired in a business combination represents goodwill that should be accounted for under FASB Statement No. 142, Goodwill and Other Intangible Assets. Thus, the specialized accounting guidance in paragraph 5 of FASB Statement No. 72, Accounting for Certain Acquisitions of Banking or Thrift Institutions, will not apply after September 30, 2002. If certain criteria in Statement 147 are met, the amount of the unidentifiable intangible asset will be reclassified to goodwill upon adoption of that Statement.
- Financial institutions meeting conditions outlined in Statement 147 will be required to restate previously issued financial statements. The objective of that restatement requirement is to present the balance sheet and income statement as if the amount accounted for under Statement 72 as an unidentifiable intangible asset had been reclassified to goodwill as of the date Statement 142 was initially applied. (For example, a financial institution that adopted Statement 142 on January 1, 2002, would retroactively reclassify the unidentifiable intangible asset to goodwill as of that date and restate previously issued income statements to remove the amortization expense recognized in 2002). Those transition provisions are effective on October 1, 2002; however, early application is permitted.
- The scope of FASB Statement No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, is amended to include long-term customer-relationship intangible assets such as depositor- and borrower-relationship intangible assets and credit cardholder intangible assets.
Copies of Statement 147 may be obtained through the FASB’s Order Department by calling 800-748-0659 or by placing an order on-line.
"Banks must end research links, regulator says," by Joshua Chaffin, Financial Times, October 9 2002 --- http://news.ft.com/servlet/ContentServer?pagename=FT.com/StoryFT/FullStory&c=StoryFT&cid=1033848813904&p=1012571727088
Complete separation of investment banking and research is necessary to stamp out conflicts of interest on Wall Street, said William Galvin, the Massachusetts Secretary of State.
"I don't think you can have a single firm that does research and investment banking," he told the Financial Times on Tuesday.
Mr Galvin has become an important voice among regulators because his state has one of the largest securities fraud divisions, and has taken a leading role with its investigation of Credit Suisse First Boston.
His comments stake out an extreme position in the debate over how to reform a securities industry where analysts have been compromised by investment banking considerations.
He and other state and federal securities regulators are currently discussing a series of reforms with Wall Street banks that could set the stage for a "global" settlement of the competing investigations.
Some banks have advocated a strengthening of the firewall separating investment bankers from analysts, while others have proposed shifting research departments into a subsidiary of the parent financial company. Both would fall short of the total separation favoured by Mr Galvin.
Mr Galvin said on Tuesday that the CSFB probe was intensifying. "It seems the further we go into this, the deeper it gets," he said.
Mr Galvin has turned up e-mail evidence suggesting the firm's research coverage was linked to investment banking fees. "It seems it was company policy to relate what was going to be said about a company [by research analysts] to investment banking," Mr Galvin said.
His investigators are planning to question Frank Quattrone, the head of CSFB's technology investment bank, which was a leading underwriter of "hot" IPOs in the late 1990s. CSFB has since changed this policy.
Massachusetts has already referred evidence to New York attorney-general Eliot Spitzer and asked him to consider criminal charges against the firm.
"Greed-mart Attention, Kmart investors. The company may be bankrupt, but its top brass have been raking it in," by Nelson D. Schwartz, Fortune, October 14, 2002, pp. 139-150 --- http://www.fortune.com/indexw.jhtml?channel=artcol.jhtml&doc_id=209652
If you didn't know any better, you'd almost feel sorry for James Adamson, CEO of beleaguered, bankrupt Kmart. Despite laying off 22,000 employees and closing hundreds of stores so far this year, the retailer continues to hemorrhage cash as sales keep plunging. Three separate government probes are looking into millions in loans and bonuses handed out by Adamson's predecessor. The investigations were spurred by an explosive series of anonymous letters from inside headquarters that tell of bogus accounting and other shenanigans just before Kmart filed for Chapter 11 in early 2002. And with the crucial holiday season fast approaching, creditors are growing frustrated, raising doubts about Adamson's future at the company, not to mention the fate of Kmart's 220,000 remaining employees.
Shuttling between meetings with employees at headquarters in Troy, Mich., and sit-downs with lawyers and creditors in New York City, Adamson has publicly struck a Trumanesque stance, taking full responsibility for the chain's fate and vowing to do whatever it takes to turn Kmart around. "If this company doesn't succeed, it's on my watch," he told a Detroit newspaper this summer. "I'll take the hit."
Actually he won't. Because despite the pitch-perfect PR, the reality is that even if Kmart goes down, Adamson will still walk away with a shopping cart full of cash. He has already received $2.5 million-the company calls it an "inducement payment"-just for coming aboard as CEO, and his annual salary totals $1.5 million. Then there are the perks guaranteed in his contract-weekly private plane service between his residences in Detroit, New York, and Florida; a car and driver in Michigan and New York; and temporary accommodations at the swanky Townsend Hotel near Kmart headquarters. A standard room there costs $320 a night.
Even if Adamson were the right person to fix the company, such perquisites might seem over the top, especially since most of Kmart's laid-off employees didn't get a dime in severance. But what's especially galling to critics is that Adamson has been a member of Kmart's board of directors since 1996--yup, the same board that okayed those tens of millions in bonuses and loans to other top executives even as Kmart slid toward the precipice. And that's not all: Adamson also headed up the board's audit committee in 2000 and 2001, which happens to be the period now being examined by the SEC and the local U.S. Attorney's office for accounting irregularities.
Meanwhile, the company has set up its own internal "stewardship review" to probe the payouts to ex-execs and alleged accounting hanky-panky. That puts Adamson in the incredibly awkward, deeply conflicted position of heading up Kmart even as his own role in its collapse is being scrutinized by underlings. The retailer had hoped to wrap up the internal investigation by Labor Day but now says its goal is to finish by year-end. Already Kmart has restated 2001's results because of an accounting error that masked $500 million in additional losses.
What's extraordinary about Kmart is not merely that its top brass rewarded themselves so lavishly while their company foundered. As anyone with even fleeting familiarity with WorldCom, Enron, and Tyco can tell you, executives at other companies have been known to do that too. Instead, the story here is that Kmart execs are still living large and getting paid handsomely, even though Kmart is deep in bankruptcy and could face liquidation. By contrast, the CEO of bankrupt US Air, David Siegel, recently took a 20% pay cut, reducing his salary to $600,000, and refused a $750,000 bonus guaranteed under his contract. "Kmart boggles the mind," says Patrick McGurn, special counsel for Institutional Shareholder Services, which advises big investors on issues like corporate governance and CEO pay. "At least Tyco still has some value for shareholders. You can't say that for Kmart. It's really a pay-for-failure situation. Since the company's in bankruptcy, the shares are likely to end up being worthless." A better way to compensate executives trying to lead their firm out of Chapter 11, experts say, is to tie their pay to how much lenders, bondholders, vendors, and other creditors actually receive when their company emerges from bankruptcy.
Continued at http://www.fortune.com/indexw.jhtml?channel=artcol.jhtml&doc_id=209652
Bogle and Siegel (from The Wharton School) on the Stock Market and Corporate Reform --- http://knowledge.wharton.upenn.edu/whatshot.cfm
What will it take to restore public trust in corporate America? And what kind of stock market returns can today’s depressed investors expect over the next decade? Ask John C. Bogle, retired founder of The Vanguard Group, and you get the impression it will take a lot of work to get even the most modest results.
It’s going to require major reform of executive compensation practices, corporate governance and accounting rules to get the public to trust public companies again, according to Bogle. But that doesn’t mean stocks will pick up where they left off two years ago. Stock investors will have to adjust to much lower returns than they enjoyed in the 1990s – perhaps an annual average of just 6-9%.
“There are just a few bad apples out there,” he said, referring to high-profile financial scandals. “But I believe the barrel is bad – the barrel with the apples is bad … I believe the corporate system, the financial system, generally is bad – is corrupt.”
Bogle, 72, has never been known for mincing his words.
In 1974, he founded Vanguard and served as chairman through 1997 and senior chairman through 1999, when he retired. Vanguard, the second largest mutual fund company, behind Fidelity, is best known for its extremely low management fees and index funds tied to indicators such as the Standard & Poor’s 500. Bogle’s view, which has been well supported by research over the past two decades, is that high trading costs, taxes and fees eat so deeply into the gains of actively managed funds that those funds rarely succeed in beating low-cost index funds. This view, and Bogle’s eagerness to express it to any audience, has long made Bogle the fund industry’s biggest gadfly.
Though retired from Vanguard, Bogle has hardly moved to the sidelines. In 2000 he founded the Bogle Financial Markets Research Center on Vanguard’s Valley Forge, PA campus. He has a busy speaking schedule, and is currently a member of The Conference Board’s Commission on Public Trust and Private Enterprise, formed this year to address issues arising from recent corporate scandals. Among the commission’s 12 high-profile members are Intel chairman Andrew S. Grove, former SEC chairman Arthur Levitt Jr. and former Fed chairman Paul A. Volcker.
On Sept. 17, the commission released the first of three planned reports on executive compensation, corporate governance and accounting. The first installment pinned much of the problem on the excessive use of qualified stock options, which give executives incentives to manipulate financial statements to boost stock prices. To discourage this, the commission recommended rule changes to require that options be carried as expenses. This would encourage companies to instead use performance-based options, which are already expensed.
The commission also said corporate directors’ compensation committees should hire their own executive compensation consultants rather than use consultants hired by CEOs. Finally, it said senior executives should be required to disclose in advance their plans to sell company stock; currently, those disclosures can come as long as 40 days after a sale.
“The light being shined on executive compensation – that was a good place to begin,” Bogle noted. “We want to get a much better link between how the executives do and the performance of their company, if you will, rather than the performance of the stock.”
Stock price, he said, “is not a good measure of executive performance at all,” adding that executives concerned about short-term price gains too often avoid making decisions that can improve their companies’ long-term health.
According to Bogle, treating all forms of options as expenses would encourage the use of performance based options. One type is profitable for the executive only if he meets certain revenue goals or satisfies other elements of a long-term corporate plan. Others might have strike prices well above the market price on the date the options are granted. Or the options might be exercisable only if the stock beats a market or industry average.
The reduced emphasis on dividends, Bogle pointed out, is partly attributable to the heavy use of qualified options. Dividends are of no value to an executive who holds options rather than actual shares. Consequently, it’s in his interest to see earnings reinvested in the company or used to buy back shares – techniques meant to boost share prices. A number of experts have argued recently that if companies were given incentives to distribute more of their profits as dividends, it would be more difficult to fudge financial reports. When a dividend check is sent, there must be cash on hand to back it.
Continued at http://knowledge.wharton.upenn.edu/whatshot.cfm
AICPA President and CEO Barry C. Melancon outlines his plans to rejuvenate the accounting culture, specifying initiatives the Institute will undertake to rebuild public trust in the financial markets and in the profession itself --- http://www.aicpa.org/pubs/jofa/oct2002/melancon.htm
WE MUST RESTORE OUR MOST PRICELESS ASSET:
All of us who are privileged to be leaders of our profession have the responsibility of preserving a legacy of honor and integrity for future generations of CPAs. We owe it to all who preceded us and all who will follow us. We can afford no tolerance for those who strayed from the commitment to put the public interest first. We must do better and we will.
What is needed is not just reform of the accounting laws, it is a rejuvenated accounting culture, both internally in corporate finance offices and externally in audit firms. The culture must build upon the profession’s traditional values, such as rigorous commitment to integrity, a passion for getting it right, a commitment to rules—not just to their letter, but their spirit, and zero tolerance for those who break them.
These values are the commitment of all of the 350,000 CPAs who are members of the AICPA across this country. We are determined to restore the image of the accounting profession and rebuild the legacy we will pass on to the next generation of accountants. We’re committed to the same goals that Congress envisioned when it passed the Sarbanes-Oxley Act and that the president articulated when he signed it.
We are committed to rebuilding confidence in the financial markets and their institutions. We’re committed to dramatically reducing the risk that future investors will fall prey to the kind of financial malfeasance that characterized Enron and WorldCom. And we are committed to something else as well: restoring pride in our profession. For us, it’s personal.
The revelations of financial abuse were a traumatic blow to everyone in the accounting profession. It has been painful to the nearly half of our members who are corporate employees, who serve as the financial conscience for thousands of corporations in America. It has been painful to the vast body of CPAs in public practice, CPAs who are not by and large involved in auditing publicly traded companies, but who concentrate on providing good advice and quality services to individuals and small businesses. Let’s not forget that small businesses make up roughly half of our economy. They are America’s engine of economic growth and job creation and they depend upon their CPAs for expertise and trusted advice. In a business world that seems to grow more complex every day, small business people need to turn to a trusted adviser to put complicated issues in context. CPAs fulfill that role.
The corporate scandals have also been painful to auditors who provide independent, objective judgments to public companies and insist on full disclosure to investors; that includes nearly a thousand audit firms.
The business scandals have been painful to members of our profession because it is made up of honest people. But hundreds of thousands of good apples do not excuse the behavior of a few bad ones. Make no mistake about it, our profession was part of the problem. And it came to embody the public’s perception of the problem.
THE PROFESSION IS INVOLVED
But no matter how small a minority caused the problems, all of us in the accounting profession are working to solve them. To begin with, we were “present at the creation” of many of the reform ideas that were recently embraced by law. We helped develop the proposal for a board to oversee auditors of public companies, an idea that evolved into the Public Company Accounting Oversight Board. We called for a requirement that auditors be hired by the board’s audit committee, not management. We agreed with a prohibition on those who audit public companies from consulting in two key areas: financial systems design and implementation, and internal audit outsourcing. And we created a public-interest test against which all reforms could be measured:
- Will it help investors make informed investment decisions?
- Will it enhance audit quality and the quality of financial reporting?
- Will it help restore confidence in the capital markets, our nation’s financial reporting system and the accounting profession?
- Will it be good for America’s financial markets and economic growth?
But we’ve looked beyond legislation. We’ve engaged in a long and serious process of introspection at the AICPA over what went wrong and what must be done to make it right.
WHAT WENT WRONG?
For executives of Enron, WorldCom and yes, for some auditors, part of the problem was simple greed or arrogance. Part of the problem was the pressure of a market in which the difference of a penny or two in earnings per share could lead to the difference of a billion or two in market cap. Part of the problem was a failure of some auditors to step up to their own responsibility. And part of it is the financial reporting model itself: The proper treatment of many issues is not clear, such as off-balance-sheet activity. Financial statements are not written in plain English and disclosure is periodic, even though the Internet allows it to be provided in real time.
Part of the problem is a GAAP model with too many rules that leaves too little room for principle-based judgment. And even where GAAP does allow for such judgment, far too many preparers don’t exercise it, opting for a form of “connect the dots” accounting that doesn’t necessarily draw a full and complete picture of a company.
Part of the problem is the fact that institutional investors and other market professionals have not traditionally provided feedback to the AICPA’s standard-setting process. In retrospect, we could and should have done more to solicit it. Now, we must demand it.
Clearly, part of the problem was some inherent weaknesses in disciplinary and monitoring processes for the profession. And part of it is the threat—real or perceived—of auditor dependency on fees from major clients.
Part of the problem is an inclination among many auditors to assume good intent. Most of those who make up the leadership of corporate America are honest, with the interests of their shareholders foremost in mind. But an auditor must carry a standard of professional skepticism into each and every audit. As President Reagan said of arms negotiations with the Soviets: “Trust, but verify.” That’s our obligation to shareholders.
These are explanations, but they are not excuses. They remind us that there is no one simple answer to the question of what went wrong. And there will be no one simple answer to the question of what must we do to make it right. The accounting profession must start with a basic commitment—a commitment that has governed the AICPA and its members since the organization was founded over a century ago.
Let me illustrate that commitment with a story about an auditor named Al Bows, who this summer was the subject of a profile in The Wall Street Journal. He went to work for an audit firm in the depths of the Depression. Public companies had just been mandated to have their financial statements certified. There were no nationally recognized standards in place, no history to draw upon. Bows took pride in helping to reform capitalism. He took pride in something else, too: his integrity. One day he discovered that the CEO of one of his client companies was secretly running a competing business on the side to siphon off profits. The client controlled a major account for Bows. But Bows told him to cut out the con game or he’d turn him in. The client was angry, but he stopped cheating his shareholders. Al Bows possessed a characteristic crucial to the profession: He had the guts to say no, even when he had a lot to lose.
WHAT INVESTORS DESERVE—AUDITORS WHO SAY “NO”
Let there be no doubt: Hundreds of thousands of members of the CPA profession say “no” every day. “No” means protecting the public interest by rejecting unsound corporate accounting practices. “No” means reducing the risk of deceit and fraud. “No” means ensuring that audited statements are not just accurate, but illuminating. “No” means questioning and challenging management. When justified, it means rejecting management’s accounting decisions. Saying “no” means saying “yes” to protecting the public interest. Only if auditors are fully prepared to say “no” will investors be fully prepared to say “yes.”
“No” is not always easy to say. But obscured by the recent focus on our profession is the fact that auditors say it every day. These stories rarely come to light because an auditor prevails on clients to do the right thing. Every day, an auditor is telling a corporate executive what must be disclosed, why an item can’t be treated in a certain manner or why a certain activity must be shown on the balance sheet.
Every year, members of the AICPA collectively conduct almost 17,000 audits of public companies that are unblemished by restatements or allegations of impropriety. That doesn’t even include hundreds of thousands of audits of privately held companies and government and not-for-profit institutions that exemplify the highest standards of integrity.
That’s the true spirit of the accounting profession, a spirit we must marshal in pursuit of a fair investment climate. We must strive for zero audit defects, knowing full well that a combination of factors will prevent us from ever achieving perfection. But when a failure occurs, we must be unrelenting in ensuring that its weaknesses are not repeated.
The president and Congress have taken a significant step. The accounting profession is determined to carry the cause forward. We realize that no single initiative will rebuild investor confidence, that no single magic bullet will put fraud or malfeasance to rest.
Months of introspection at the AICPA have brought us to the conclusion that we have six leadership roles to fulfill. All of them require cooperation with other important players, who have jurisdiction in many vital areas.
First, the AICPA has a role as a standard setter. While the new Public Company Accounting Oversight Board has broad responsibilities, CPAs have a responsibility to set standards for their own profession, just as professionals do in medicine, engineering and architecture.
- To ensure that our standard-setting capacity is as robust as possible, the AICPA will make it a priority to obtain greater involvement of the users of financial statements in setting auditing standards.
- We are developing new guidance regarding an auditor’s potential dependency on fees from large clients, including discussion with audit committees about potential dependency and expanded rotation requirements for key personnel. The guidance would also consider compensation policies that reward partners primarily based on auditing proficiencies and policies that prevent a firm from penalizing a partner who says “no” at the risk of losing a client.
Second, the AICPA has a role as a liaison between market institutions and corporations, jointly shaping programs and policies to guard the interests of investors. Reducing the incidence of financial fraud will require a partnership among auditors, corporate management and all financial professionals, with the goal of achieving an environment of fraud-free financial reporting.
- We will design antifraud criteria and controls intended for public corporations, targeted for introduction next June. We invite corporate America to work with us. We are calling on the Auditing Standards Board to enhance our existing attestation standard for CPAs to test and report on client antifraud controls and programs and to develop ways to communicate the results to the public.
- We will be sponsoring a summit, before the end of this year, of financial executives, corporate directors, audit committees, stock exchanges, analysts and regulators to identify new antifraud initiatives and collaborate in implementing them.
Third, the AICPA has a research role. Academic research can provide new insights into the who, what, when, where and why of corporate fraud. These insights will improve corporate-fraud-prevention controls, strengthen undergraduate education and enhance audit procedures to detect fraud.
- Today, I am pleased to announce that the AICPA, the University of Texas at Austin and the Association of Certified Fraud Examiners are jointly establishing an Institute for Fraud Studies. We call upon leaders in corporate America and CPA firms to participate in this initiative. We are committed to incorporating the research results into the task of standard setting. One of the outcomes must be improved investor education. For that reason, one of the first research projects will be to study how investors can help protect themselves against fraud.
Fourth, the AICPA has an educational role. We are developing training programs aimed at combating fraud.
- We will initiate discussions with the American Accounting Association, the Federation of Schools of Accountancy, chairpersons of university accounting programs and college textbook publishers aimed at promptly incorporating fraud prevention materials into the accounting curriculum and university textbooks. This will give students the knowledge and skills to understand the fundamental characteristics of fraud, identify factors that may indicate it exists and acquire enhanced interviewing techniques. The AICPA will work with academic institutions to develop appropriate materials, targeted for inclusion in college courses in the fall of next year.
- We further believe all members of the AICPA should commit more time to continuing education in the area of fraud detection. While considerable ongoing professional education is required to maintain professional standards, we are calling on audit and finance professionals dealing with public companies to commit at least 10 percent of their continuing education to the area of fraud detection.
- We are urging stock exchanges to mandate effective antifraud training for all members of management, boards of directors and audit committees. As a public service, by the end of this year, we will develop and make available, free of charge, training programs focusing on the roles and responsibilities of management and those in corporate governance.
Fifth, the AICPA has a role to play in advancing the level of financial reporting. Achieving more transparent financial reporting is central to ensuring fair markets and restoring investor confidence. We are eager to pursue this goal in concert with FASB and with leading corporate organizations. We seek to work with all interested parties, but we are prepared to move forward on our own if necessary.
- One of our first steps is to initiate a debate within the accounting community on how to differentiate between the needs of widely held and privately held businesses, and how to reform GAAP to reflect this reality. Given the media focus on public companies, it’s easy to lose sight of both the importance of small business and its unique reporting needs. As a first step in addressing this, the AICPA is asking all of our committees and those of state societies that deal with small-company issues to put this high on their agendas. Feedback is due by the first quarter of next year.
- We will work with FASB to ensure an improved reporting model is built that will provide investors with higher-quality information—addressing such issues as off-balance-sheet activity, liquidity, financial performance indicators and unreported intangibles.
- In addition, we’re working with the Canadian Institute of Chartered Accountants to lead the way in updating the reporting model. We’ve jointly developed the Value Measurement and Reporting Collaborative, which brings together stakeholders in the financial reporting process from around the world to determine the best methodologies for value measurements and reporting. This will enable investors to see more information about what makes a company successful. It will also help boards of directors and senior management to make better strategic decisions.
- We fully support the SEC’s current proposal to expand and enhance the disclosure of estimates and accounting policies. When the new rules are finalized, we will provide our members with tools to implement it. The additional disclosures should be included either as part of the financial statement disclosures or as part of management’s discussion and analysis (MD&A). And we fully support the auditor’s examination of MD&A. As well, the Auditing Standards Board is seeking input from users of financial information as to other types of information that should be communicated by the auditor.
Sixth, the AICPA has a role in promoting strong corporate governance and internal control systems. A public company’s ability to withstand pressures to provide false information to the public depends largely on those factors.
For that reason, we are calling on the Auditing Standards Board to revise existing internal controls and reporting standards so that the public will be put on notice when the auditor communicates internal control weaknesses to the audit committee. Situations that will be considered as constituting reportable conditions will include one individual holding the dual positions of chairman of the board and CEO or an audit committee that is not fulfilling its mission. It may include lack of mandatory antifraud education or lack of a code of conduct.
In fulfilling all of these roles, the AICPA has an overriding mission: to shape an accounting culture for the future that surpasses the legacy of our past.
Over the past few months, certainly one good thing has occurred: The importance of the audit has been reaffirmed loud and clear. Now, we must build on its core value.
The AICPA will be both a watchdog and a source of leadership. We pledge to be a force for raising new issues and examining issues that are raised by others. We will serve as common ground for all in the profession and those involved in the financial reporting process to bring their concerns and proposals.
To be certain, none of us—auditors, corporations or investors—will look back fondly on this year. But the 350,000 members of the AICPA are concentrating on looking forward. We’re looking forward to implementing the fundamental reforms enacted by Congress. We’re looking forward to working with lawmakers, corporations and the public to implement new reforms as necessary and to rebuilding the faith of investors in the audited financial statement as an open window into publicly traded companies. We’re looking forward to reclaiming our profession’s heritage as a bedrock of business integrity and continuing our historic role as trusted advisers to businesses of all sizes and protectors of the public interest.
It will not be easy. But we are committed to it. We are committed to moving forward. We will rebuild trust in our profession brick by brick
Building Public Trust:
The Future of Corporate Reporting
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•Information is the lifeblood of the capital markets.
• Recent scandals and business failures have undermined investors ’ confidence in those responsible for the content and quality of the information companies report.
• This includes company executives, boards of directors, independent auditors, third-party analysts and information distributors — the Corporate Reporting Supply Chain.
•To restore public trust, every participant in the chain must embrace nd practice a spirit of transparency, a culture of accountability and individual integrity.
•The Three-Tier Model of Corporate Transparency, a new vision of corporate reporting, encompasses Global GAAP, industry-based standards and company-specific information.
•Good external reporting requires sound internal management, clear articulation of a value proposition and reporting on the measures most relevant to value creation.
•New Internet technologies will improve the quality and speed of reporting and enhance corporate transparency.
•The auditing profession must address current concerns bout its work and the need to assure information reported at all three tiers.
October 5, 2002 from FinanceProfessor [FinanceProfessor@lb.bcentral.com]
Prosecutors got another step closer to Martha Stewart as Douglas Faneuil, the assistant to Ms. Stewart’s broker, pleaded guilty to a misdemeanor for accepting “hush money” in return for not saying more about why Ms. Stewart sold her shares. In related news Martha Stewart resigned from the NYSE board which some are construing
Months after it was first expected, former Enron CFO Larry Fastow was arrested for fraud, money laundering, and conspiracy charges this week. (He was even led off in handcuffs!) Fastow is facing charges that could lead to over 40 years in prison and the return of over $37 million. However, it has been suggested that prosecutors are really Fastow to testify against Ken Lay and possibly Jeff Skilling and therefore may be willing to cut a deal.
http://news.bbc.co.uk/1/hi/business/2292733.stmhttp://www.nytimes.com/2002/10/03/business/03FAST.html http://www.washingtonpost.com/wp-dyn/articles/A35434-2002Oct2.html http://www.washingtonpost.com/wp-dyn/articles/A35471-2002Oct2.html
One thing that has become abundantly apparent was that Enron’s vaunted management was not as good as had been advertised. Many of their projects were failures but then hidden from investors and analysts which only saw the successes. It was the presence of these bad projects that eventually led to the collapse of the shares. (The article has a great explanation yet as to how Enron used its partnerships to shift unwanted assets off of the Enron balance sheet while simultaneously generating a gain on the sale.) http://www.nytimes.com/2002/10/03/business/03FAIL.html
One consequence of the corporate governance scandals and new reforms (such as holding executives personally liable) is that director and officer insurance has become harder to obtain and prices have risen, sometimes four fold. D&O insurance is designed to protect directors and officers from lawsuits that stem from their roles at the firm. Another likely consequence will be that executives (who are now taking on more risk) will demand more pay. http://www.cfo.com/article/1,5309,7797,00.html
To be in business is to take risks. With less D&O insurance and more public scrutiny, some CEOs are now suggesting that they worry about becoming too risk averse (remember, due to poor diversification and often misaligned incentives, executives are often more risk averse that shareholders would prefer) and that this risk aversion may hamper, not only their own companies, but the economy as a whole. (In many ways, what they are warning of is a return to the 1970s management model where incentives were not aligned with shareholders (Sort of a pre Jensen/Murphy 1990 world.) http://www.nytimes.com/financialtimes/business/FT1031119858165.html
Tyco’s board probably knew about pay: Tyco International has said that it was unaware of the extravagant loans and pay given to executives, but minutes of the board’s compensation committee show it knew of many of the payments months before the board took steps to disclose them, The New York Times reported Monday. (I cannot decide if this makes me feel better or not--on one hand I hope they knew, but then again, if they knew and let it go on….well, like I said I can not decide). http://www.msnbc.com/news/811710.asp
The news on the Adelphia Scandal is that the Rigases were indicted on more charges this week. The family is maintaining that they did nothing wrong and the father John Rigas made a rare public statement: “My family and I have always acted with integrity and honesty and are committed to restoring our credibility and that of Adelphia." While he may believe that, I am hard pressed to fid many others that are willing to overlook the self-dealing that seems to have occurred. But as we say in the US “innocent until proven guilty” so, maybe.
http://www.msnbc.com/news/811816.asphttp://www.washingtonpost.com/wp-dyn/articles/A57468-2002Sep23.html http://news.bbc.co.uk/1/hi/business/2294411.stm http://www.washingtonpost.com/wp-dyn/articles/A35367-2002Oct2.html
The whole research-investment banking relationship has to be changed. Now Salomon received a $5 million fine for issuing misleading research reports. It is for just such actions that the SEC is pushing to separate the investment banking and the research divisions. (See below in the Financial Institutions Section)
Ok, so how widespread was the granting of IPO shares and other favors to CEO’s in attempts to court their firm’s business? After the revelation earlier that Saloman Smith Barney gave Bernie Ebbers the opportunity to participate in hot IPOs, a congressional panel is now accusing Goldman Sachs of doing the same with over 20 firms including Ford and Disney! (what would Mickey say?!) While the legality is debatable, it sure seems like a bribe.
Several top executives including, WorldCom’s Bernie Ebbers, are now facing more legal problems as NY State sues for a discouragement of profits from their IPO dealings. http://news.ft.com/servlet/ContentServer?pagename=FT.com/StoryFT/FullStory&cid=1031119780783&p=1014232938216
Socially responsible investing has taken on many meanings. From not investing in tobacco and gambling stocks to environmental consciousness, but SocialFunds.com is also taking the corporate governance banner on. While admitting the Sarbanes-Oakley Act is an improvement, they are pushing for more including an end to staggered boards, more disclosures, and mandatory expensing of options. http://www.socialfunds.com/news/article.cgi?sfArticleId=936
Boards of Directors are supposed to stop these corporate excesses. The Boards are elected by shareholders and are the first line of defense against the corruption we have seen. Business Week has an interesting story on the best and the worst of US boards. (GREAT for class examples!) http://www.businessweek.com/bwdaily/dnflash/oct2002/nf2002103_8277.htm
. . .
The bulk of economic data suggests that the US economy is growing very slowly. For example, there were fewer jobs, chain store sales slowed yet again, but many leading economists suggest a recession is not in the cards.
. . .
Merrill Lynch’s new email training (wow that has got to be fun!) came under fire from Cnn’s Lou Dobbs. Dobbs correctly claims that the firm is just trying to prevent from being sued later when the wrong email was saved.
US Governmental Accounting Office (GAO) Yellow Book --- http://www.gao.gov/press/pressreleaseqa.pdf
|GAO PRESS STATEMENT
Tuesday, July 2, 2002
Today, David M. Walker, Comptroller General of the United States and head of the U.S. General Accounting Office (GAO), announced release of important guidance on auditor independence requirements under Government Auditing Standards. These standards, which were first published in 1972 and are commonly referred to as the "Yellow Book," cover federal entities and those organizations receiving federal funds.
Various laws require compliance with the Comptroller General’s auditing standards in connection with audits of federal entities and funds. Furthermore, many states and local governments and other entities, both domestically and internationally, have voluntarily adopted these standards.
On January 25, 2002, GAO issued significant changes to Government Auditing Standards related to auditor independence, which substantially changed the previous standard especially regarding nonaudit, or consulting services. In issuing the new standards in January, the Comptroller General stated that protecting the public interest and ensuring public confidence in the independence of auditors of government financial statements, programs, and operations, both in form and substance, were the overriding considerations in his decision to issue these new standards. At the time, the Comptroller General urged the American Institute of Certified Public Accountants to raise its standards to those contained in Government
Because of the new independence standards’ significant effect on audit organizations, when GAO issued the standard, it indicated plans to subsequently provide further guidance to assist in its implementation. This new guidance responds to questions related to the independence standards’ effective date, implementation time frame, underlying concepts, and application in specific nonaudit circumstances.
In releasing this guidance, the Comptroller General emphasized that "recent private sector accounting and reporting scandals have served to re-enforce the critical importance of having tough but fair auditor independence standards to protect the public and insure the credibility of the auditing profession." He again called on other standard setters "to follow the lead of government auditors by adopting principle-based standards that make clear that auditors are to be independent in both fact and appearance.
According to the Comptroller General, in making judgments on independence under Government Auditing Standards and applying the principles and safeguards established by the new independence standards, audit organizations should take a "substance over form" approach and consider the nature and significance of the services provided to the audited entity on a facts and circumstances basis. Before an audit organization agrees to perform nonaudit services, it should carefully consider the need to avoid situations that could lead reasonable third parties with knowledge of the relevant facts and circumstances to conclude that the auditor is not able to maintain independence in conducting audits. It is important that auditors always be viewed as independent both in fact and appearance.
Importantly, when the independence standard was issued, GAO called for its provisions to be applicable to all audits for periods beginning on or after October 1, 2002. Because of the breadth of changes in the amendment and to allow additional time for the new independence standard’s effective implementation, GAO is extending its effective date to be applicable to all audits for periods beginning on or after January 1, 2003.
Also, GAO’s original intent was that any nonaudit service contract awarded on or after January 25, 2002, would not be exempt, or grandfathered. However, GAO has found that some audit organizations may not have understood this or were not aware of the standard until sometime after it was issued on January 25, 2002. To be fair to these audit organizations and other interested parties, GAO will exempt, or grandfather, all nonaudit services that were initiated, agreed to, or performed by June 30, 2002, provided the work is completed by June 30, 2003.
The Comptroller General received input from his Advisory Council on Government Auditing Standards on the guidance and the major concepts were discussed with other interested parties. The council includes 21 experts in financial and performance auditing and reporting drawn from all levels of government, academia, private enterprise, and public accounting.
An electronic version of Government Auditing Standards: Answers to Independence Standards Questions (GAO-02-870G, July 2002) is available on the GAO Internet site ( http://www.gao.gov/govaud/ybk01.htm ).
Continued at http://www.gao.gov/press/pressreleaseqa.pdf
"Taking On the Sage of Wall Street," by Janice Revell, Fortune,
October 14, 2002, pp. 64-67 --- http://www.fortune.com/indexw.jhtml?channel=artcol.jhtml&doc_id=209715
FORTUNE catches up with Arthur Levitt to discuss wily politicians, born-again CEOs, and music picks for shell-shocked investors.
Long before the current wave of corporate malfeasance, former SEC chairman Arthur Levitt was pressing hard for serious reforms--the expensing of stock options and the separation of auditing and consulting functions, to name just two--that policymakers now suddenly view as critical. The 71-year-old Levitt, who stepped down from the SEC in February 2001, is now providing a no-holds-barred description of his battle to reform Wall Street in a new tome entitled Take On the Street (Pantheon Books), due out this month. FORTUNE caught up with Levitt to discuss wily politicians, born-again CEOs, and music picks for shell-shocked investors.
Q: Why write this book?
A: I wrote it for my Aunt Edna. She died some years ago, but to me she represented the investing "everyperson." I wanted her to understand what she could do to protect herself.
Q: You certainly don't pull any punches in the text.
A: Almost all of the problems that investors are experiencing can be traced to legislators who've been motivated by campaign contributions and care nothing at all for the well-being of the individual investor. The public needs to recognize that they are the most potentially powerful lobbying force in America, and as of today they're virtually impotent.
Q: So are you having any problems finding lunch dates on Capitol Hill and Wall Street?
A: Some of my closest friends are people I grew up with in this industry. I think they understand that a Wall Street that is perceived to be fair is a much better environment for them to operate in.
Q: We've had crises of confidence in the past. Is this the worst you've seen?
A: Yes, it is. I have never seen the amount of anger and disillusionment with the process and the practitioners as this round has called for. I defy you to name three business leaders who are recognized by the general public for probity and integrity. You'd probably start and stop with Paul Volcker.
Q: But is this really a case of just a few bad apples spoiling it for everyone else?
A: No. It is a systemic problem represented by an almost two-decades-long erosion of ethical values on the part of American business.
Q: So are we going to see a lot more corporate blowups?
A: I don't know how much more fraud you're going to see, but you will certainly see restatements predicated on exaggeration and pushing the envelope.
Q: Is anything good going to come out of all this turbulence?
A: I believe that embarrassment and humiliation have already caused societal change. You've seen CEOs of companies that have been in the limelight suddenly sounding like latter-day Elmer Gantrys, calling for the expensing of stock options and so on. This would have been laughed at a few years ago.
Q: You mention in the book that you own six Macs and a digital music player. Can you recommend any tunes to calm investors?
A: The music I play on my iPod when I walk my dogs is Mozart, which I find very soothing.
From The Wall Street Journal Accounting Educators' Review on September 27, 2002
Accounting Firms Are Still
REPORTER: Cassell Bryan-Low
DATE: Sep 23, 2002
TOPICS: Auditing, Auditing Services, Auditor Independence, Consulting, Audit Quality
SUMMARY: Even though recent legislation restricts the consulting work that auditors can perform for their clients, approximately fifty-percent of total revenue in the Big Four accounting firms is from non-audit services. Questions focus on the advantages and disadvantages of providing non-audit services to audit clients.
1.) Why do auditors need to maintain independence? Does performing non-audit services for audit clients compromise independence? Support your answer.
2.) What type of non-audit services can auditors perform for their audit clients? What non-audit services are prohibited under the new legislation? What is the underlying logic of prohibiting certain non-audit services while allowing other non-audit services?
3.) Discuss the comment made by former Securities and Exchange Commission Chairman Arthur Levitt concerning the industry serving public interest and the possible need for stronger legislation. Do you agree with Mr. Levitt?
4.) Discuss the advantages and disadvantages of accounting firms offering a wide range of services. Discuss the advantages and disadvantages of accounting firms limiting services to audit, tax and closely-related services.
By: Judy Beckman, University
of Rhode Island
Reviewed By: Benson Wier, Virginia Commonwealth University
Reviewed By: Kimberly Dunn, Florida Atlantic University
"Even Without Consulting Arms, Accounting Firms Still Consult," by Cassell Bryan-Low, The Wall Street Journal, September 23, 2002, PAGEC1 --- http://online.wsj.com/article/0,,SB1032736856302232033.djm,00.html
The new federal legislation prevents accounting firms from providing various services to their publicly traded audit clients. Among these: information-system design, internal auditing, bookkeeping, appraisal and valuation work, actuarial services, investment banking, legal work and management tasks. When such often-lucrative contracts are in place, the thinking goes, auditors may be less likely to challenge their clients on accounting issues for fear of jeopardizing this other business. In the case of internal auditing, an extra concern is that auditors could end up auditing their own firm's work. (In the case of Enron, Andersen earned $25 million in auditing fees in 2000 and $27 million for other work.)
"Firms are going to have to assess their current range of service offerings and decide which ones will continue to be viable economically for them," says J. Michael Cook, retired chief executive of Deloitte & Touche LLP. They need to ask: "Do we want to be Howard Johnsons and offer 28 flavors, or are we better served in offering only chocolate, vanilla and strawberry: audit, tax and closely-related services?"
Almost three-quarters of fees paid to accountants by audit clients in 2001 were for nonauditing services, according to an analysis of regulatory filings by 21 of the Dow Jones Industrial Average's 30 companies. Overall, audit fees will account for closer to half of all revenue this year, once all of the firms have spun off their large consulting units, industry experts say.
Accounting firms are quick to note that they can continue to provide the various services, just not to their audit clients. However, there is one drawback: In relying on nonaudit clients, the firms no longer can draw on audit relationships to line up contracts.
"Obviously, we're looking at the provisions of the law and will do what we need to do," says Deborah Harrington, a Deloitte spokeswoman, echoing sentiments at fellow Big Four members Ernst & Young LLP, KPMG LLP and PricewaterhouseCoopers LLP.
One element of the legislation giving accountants pause is the restriction on sales to their public audit clients of "expert services related to the audit." Auditors fear a broad interpretation could impinge on lucrative tax-consulting work. How regulators interpret that could affect what the firms spin off.
Even before the legislation, market forces were at work to the same end. PricewaterhouseCoopers, the nation's largest audit firm, recently sold its bankruptcy-and-litigation-related services business, which had $170 million in revenue for the fiscal year ended June 30, to boutique firm FTI Consulting Inc. It sold a division dealing with valuations for mergers and other transactions to McGraw-Hill Cos.' Standard & Poor's Corp., and it also sold a lobbying practice and most of a broker-dealer business. Partners earlier this month approved the sale of the information-technology consulting unit for $3.5 billion in cash and stock to International Business Machines Corp., a pact expected to close early next month and ending a roughly two-year divestiture effort.
Samuel DiPiazza, the accounting firm's chief executive, disputes that such services create a conflict of interest, but says, "the perception is such that it makes it harder to operate."
Another pressure for divestitures: resistance accountants can face from their own audit clients in offering services to other firms. For example, a bank may not be thrilled for its auditor to represent a distressed company against which it has claims.
Eugene O'Kelly, KPMG's CEO, says legal services that the firm provides overseas to U.S. registrants are "under strategic review." He added that the U.S. firm in recent years had scaled back other services restricted by the recent legislation. Mr. O'Kelly says his firm had lost some internal-audit-outsourcing clients as a result of the legislation but has in turn picked up others from rivals.
Beth Brooke, Ernst & Young's global vice chairman for strategy, says: "As a general business matter, we are always evaluating the level of services we provide." She adds that the legislation is affecting how business is being conducted, more than how much business is being done. At the firm's global partner meeting in Orlando, Fla., Sunday, senior executives -- including Ms. Brooke -- made presentations on strategy going forward emphasizing both retention of current audit partners and ways to develop other business relationships with nonaudit clients. Ernst & Young and KPMG shed their large consulting divisions in 2000 and 2001, respectively.
The last big firm to announce it would divest itself of its information-technology consulting business was Deloitte. In February, it said it was reluctantly doing so to allow audit clients to continue to use Deloitte Consulting without raising concerns about auditor independence. Deloitte plans to separate the unit by year's end as a privately owned partnership, to be called Braxton, in which Deloitte intends to retain a minority interest of as much as 20%, subject to regulatory approval.
Corrections & Amplifications:
Pricewaterhouse Coopers LLP recently sold its U.S. bankruptcy business to FTI Consulting Inc. The above article incorrectly stated that the division also provided litigation-related services, which PricewaterhouseCoopers continues to provide.
Continued at http://online.wsj.com/article/0,,SB1032736856302232033.djm,00.html
At last some progress is being made where the apple is the most rotten.
Citigroup will propose a settlement to federal regulators that includes plans to sever ties between its research and investment-banking businesses and pay a fine of hundreds of millions of dollars. The plans were detailed in a meeting with Spitzer.
"Citigroup Is Ready to Settle Probes Into Stock Research: Proposal Would Split Banking, Research, May Include a Multi-Million Dollar Fine." by Charles Gasparino, Susan Pulliam, and Randall Smith, The Wall Street Journal, September 27, 2002 --- http://online.wsj.com/article/0,,SB1033094081491689833,00.html
Citigroup Inc., seeking to end several investigations into its stock-research practices, will meet with federal regulators Friday to propose a settlement that includes plans to completely sever ties between its research and investment-banking businesses, and pay a fine that could reach hundreds of millions of dollars, people familiar with the matter say.
The plans were detailed in a meeting Thursday with New York State Attorney General Eliot Spitzer, who has been investigating the activities of Citigroup's Salomon Smith Barney securities unit. His investigation has centered on whether Salomon's research analysts published overly rosy stock recommendations to win investment-banking business, and whether the firm allocated initial public offerings of stock to corporate executives in a bid to win their firms' financing business. A Citigroup spokeswoman declined to comment Thursday.
In the meeting with Mr. Spitzer, lawyers from Citigroup floated a plan that envisions the formation of a separate research unit within the financial-services giant -- in hopes of creating a model for the industry. The attorneys also conceded that Citigroup considers the current industry model for research to be "broken," and ripe for change, according to a person with knowledge of the matter.
The degree to which the firm would separate the analysts at its Salomon Smith Barney securities unit from the firm's investment and commercial bankers isn't clear. Citigroup lawyers said they would provide more details to the Securities and Exchange Commission, the Nasdaq Stock Market and the New York Stock Exchange during the meeting today. The thrust of Citigroup's efforts would be to resolve all of its regulatory liabilities at once.
• SEC May Punish Executives
Who Snared Shares of IPOs
SEC Chief Pitt to Seek a Split
Of Street's Banking, Analysts
Bob Jensen's "Rotten to the Core" threads are at http://www.trinity.edu/rjensen/fraud.htm#Cleland
In a speech to institutional investors, SEC Chairman Harvey Pitt introduced a new and creative approach to accounting reforms. He called on these major shareholders to exert their influence to help improve corporate accountability. http://www.accountingweb.com/item/91441
AccountingWEB US - Sep-25-2002 - In a speech to the Council of Institutional Investors, Securities and Exchange Commission Chairman Harvey Pitt introduced a new and creative approach to accounting reforms. He called on these major shareholders to exert their influence in constructive ways to help improve corporate accountability.
"After all, institutional investors are really just large agglomerations of regular folks," explained Chairman Pitt. "People who choose to invest their money in the same mutual fund ... [are] people busy doing their jobs, lacking time to research stocks and bonds in which to invest for their retirement or their children's education. So they give their money and their trust to you."
Institutional investors can prove themselves worthy of that trust, Chairman Pitt said, by playing a bigger role in overcoming the negative forces that led to recent accounting scandals. To help institutional investors in this role, the SEC is encouraging several types of actions:
- Disclosure of voting policies. Individuals who invest in mutual funds cannot vote their own shares, so mutual funds should make it a policy to vote in their clients' best interests. To discourage or expose any potential conflicts of interest, the SEC is proposing rules that would require funds to disclose their voting policies.
- Disclosure of fund portfolio holdings. The SEC is also currently preparing a proposal to require greater and more frequent disclosure of fund portfolio holdings. Although this proposal will involve some difficult and controversial issues, Chairman Pitt said a vote is expected on the proposal by year-end.
- Leaving more decisions about stock options to investors. Because they reward short-term results, stock options can knock the interests of management out of alignment with the interests of shareholders. To help bring the two back into alignment, the SEC is looking beyond the mandatory expensing of stock options, (which does not seem to address the real problem), and Chairman Pitt is leaning toward a solution that would allow shareholders to vote on which of the permissible accounting methods to use.
Continued at http://www.accountingweb.com/item/91441
Bob Jensen's threads on proposed reforms in the wake of recent accounting scandals can be found at http://www.trinity.edu/rjensen/FraudProposedReforms.htm
The SEC charged former executives of Homestore Inc. with arranging fraudulent "round-trip" revenue transactions involving online advertising. In effect, these sham transactions allowed Homestore to recognize its own cash as revenue. http://www.accountingweb.com/item/91577
Round tripping was even more of a scandal among energy traders such as Enron, Dynegy, Duke Power and El Paso Corporation.
Bob Jensen's threads on revenue round tripping can be found at http://www.trinity.edu/rjensen/ecommerce/eitf01.htm#RoundTripping
Your comments are VERY HELPFUL. Would you mind if I include them in my next edition of New Bookmarks? See http://www.trinity.edu/rjensen/bookurl.htm
From: David Storhaug [mailto:firstname.lastname@example.org]
Sent: Wednesday, September 25, 2002 1:36 AM
To: Jensen, Robert Subject: What Can We Learn From Enron?
This evening I found time to catch up on my professional digests received by e-mail (including CPAS-L), and noted that you had invited comments to your planned presentations for 9/30/2002. By coincidence, earlier today I attended a seminar "Is there a Crisis in Financial Reporting?" put on by George Letcher and Ray Thompson, accounting professors from Univ Pittsburgh - Johnstown.
Not surprisingly, there is some overlap in your separate presentations and there are some differences. They based their presentation on 10 major problems needing to be addressed to improve the financial reporting process, as taken from a joint position paper (JWSP) prepared by the Big 5 and AICPA.. Their lead in was an overview of what went wrong with Enron, buttressed by extra details on Enron woven into each of the 10 points.
They addressed the same points as included in your presentation's reference to the following quote by Mr. Volker.
Moreover, accounting firms themselves were caught up in the environment – - to generate revenues, to participate in the new economy, to stretch their range of services. More and more they saw their future in consulting, where, in the spirit of the time, they felt their partners could “better leverage” their talent and raise their income.
I.e. Over the years there has been a tendency for CPA's, (particularly some key players at Arthur Andersen) to gradually evolve from being professionals (with skepticism and remembering their duty to serve third parties) to being merely sales people whose primary drive was to please only the client at all costs.
My personal observation is that the removal of the prohibition against soliciting only aided and abetted the above, yet I seldom hear that mentioned.
My recollection and summary of the 10 points presented by George Letcher and Ray Thompson were:
1 Pressure to perform: culture at SEC listed companies to meet and beat quarterly earnings expectations at all costs.
2. Complexity: Ever increasing array of complex financial arrangements and structured transactions being created by investment bankers, financial engineers and CPA's. Ken Lay hired Arthur Anderson because the prior CPA firm wasn't "creative enough".
3. Standards overload: recent history of FASB, AcSEC, and SEC had been "abuse driven" rather than principles based. Abuses lead to complex standards which only invite a response of trying to find yet another loop hole.
4. Internal control and down sizing: A common fact of life in current American corporate landscape, but often with negative effects on internal control and segregation of duties, along with overwhelming workload and insufficient time to complete tasks. The structure was not in place to properly handle Watkin's attempts to call attention to the problems.
5. Related parties: most every corporation has some related party transactions, but Enron had over 3000. This is a fact which should have raised flags by itself.
6. Off balance sheet items and special purpose entities. They went though the history of the 3% rule and illustrated how this rule (originally from leasing) was perhaps distorted to for its use in Enron's SPE's. However an additional factor was the "undisclosed" but improper ownership of even the 3%.
7. Materiality: They went through the mechanics of how Enron / AA reached their distorted conclusion that $51 million was not material, primarily by the use of "normalized accounting", a concept that is sometimes used in determining materiality when auditing companies which are very new and have no prior track record; so it is sometimes proper to determine a materiality level based on income derived (imputed) from other companies in a similar business. It was questionable to use this concept with Enron since it was not a new company.
8. Pro forma earnings:
9. Audit committees: They went through the makeup of Enron's audit committee, pointing out the remoteness of many, and pointing out how one educator might have had his independence called into question because of the large donations Enron made to his University.
10. Consulting services and independence. They went through the history of Arthur Levitt's attempts to rein in this, and how the AICPA and Big 5 beat him back, and how this helped create the backlash of the recent PCRA enacted into law.
The above was all very interesting, but not always directly applicable to my practice as a local practitioner with non-public clients. I was looking for talking points for potential use with legislators in an anticipated need to react to the expected "cascade effect" from SEC practice down to the small business practice. It wasn't the main topic of discussion, but in talking to various participants, and also visiting with Mr. Letcher and Mr. Thompson, I came up with the following
distinctions between SEC level clients and practice and NON-SEC clients and practice:
1. Unity of ownership and management's for most NON-SEC clients, compared to the separation of ownership and management with SEC companies. Specifically, the ownership of SEC companies tends to be "uninformed".
2. Absence of the quarterly drive to meet earnings expectations with NON-SEC clients.
3. Non SEC companies are more apt to have a close, perhaps even personal relationship with their banker (who often exercises restraint over the client). By contrast, SEC clients most often issue bonds to an impersonal market.
4. Lesser, perhaps no need for restrictions on consultation with NON-SEC clients, since the smaller companies will be hurt, not helped, by restrictions on consulting. Smaller companies usually don't have the luxury of being able to afford two sets of professionals (auditors and consultants) and the cost of getting these two sets familiar with their business. Instead they need the efficiency gained by leveraging the auditor's familiarity with the business by allowing him to also be a consultant (in most cases).
5. Smaller NON-SEC companies are more heavily influenced by the urge to save income tax. While they have some of the same aspect of trying to beat earnings expectations (because it will help them maintain good relations with their banker) a countervailing force is their strong urge to hold down income tax.
The above 5 points are not directly related to your invitation for comments, but I found the analysis helps to put the both the SEC and non-SEC situations into better perspective.
Dave Storhaug, CPA
Hard To Catch Exec
Dow Jones International News Service via Dow Jones
The Wall Street Journal's Heard on the Street
By Ken Brown
September 24, 2002
NEARLY $2 BILLION in revenue disappears at Xerox Corp. More than $3.8 billion in expenses are wiped out at WorldCom Inc. And $1.2 billion in shareholder equity is vaporized at Enron Corp. A reasonable person might ask how the accountants missed such massive financial time bombs.
The answer could be that they were looking in the wrong place.
A new study by two accounting professors questions the methods used by the major auditing firms to study the books of their clients. The professors say those methods make it almost impossible for auditors to catch a client's highest-level executives cooking the books, even as most major accounting blowups, including those at Xerox, WorldCom and Enron, involve a company's top brass.
The study, by Steve Sutton of the University of Connecticut in Storrs, Conn., and Charles Cullinan of Bryant College in Smithfield, R.I., argues that over the past two decades auditors have gradually focused more on how companies generate their financial data -- the computerized bookkeeping programs and internal controls that are supposed to act as a check on the system -- than on the numbers themselves. That is in contrast to the older style of auditing, under which accountants dug deeply into corporate accounts, looking at thousands of transactions to determine if the bookkeeping was correct.
The flaw in this changed approach: While the computer programs and internal controls that the auditors now rely on do a great job preventing low-level employees from swiping the petty cash, they can be circumvented by top executives, the folks who shift millions or billions rather than thousands of dollars.
Relying on the controls rather than looking at the specific accounts "does reduce your likelihood of detecting fraud, which we already weren't very good at," says Mr. Sutton, who believes auditors should be doing more work on the nitty-gritty of a company's operations. "I think we may have swung too far and we have to go back and look more at the transactions and the balances," he says. "And, I think, post-Enron, people are doing this somewhat anyhow." But doing a more thorough job of examining companies' books means that accounting firms will have to charge more for their audits, he maintains.
The shift in the way accountants audit their clients' books can be traced to two developments dating from the early 1980s. First, companies increasingly turned to computers to manage their finances. Second, intense competition caused the fees for auditing to fall as much as 50% from the mid-'80s to the mid-'90s. That forced auditors to cut costs themselves, and they did it by cutting back on the labor-intensive process of sifting through dozens, or even hundreds, of corporate accounts. "The way they've looked to become more efficient is to put more reliance on internal controls, which allow you to do less work on account balances and transactions," Mr. Sutton says.
The paper, "Defrauding the Public Interest: A Critical Examination of Reengineered Audit Processes and the Likelihood of Detecting Fraud," was published in the most recent issue of Critical Perspectives on Accounting, an academic journal that tends to find shortcomings of the major accounting firms. The professors' work is based on an analysis of enforcement actions by the Securities and Exchange Commission between 1987 and 1999. The data show that, of the 276 frauds that took place during that time, the company's chief executive was involved about 70% of the time. Interestingly, the researchers also found that the incidence of fraud in the last two years of the study period increased to 36.5 frauds per year from about 20 annually in the study's first 10 years. In those last two years, senior executives other than the CEO were involved in 19% of the frauds.
Robert Bricker, an accounting professor at Case Western Reserve University in Cleveland, who had no involvement with the paper, agrees that auditors' reliance on internal controls is a weakness in the system. "If internal controls exist, they can be circumvented" by top executives seeking to manipulate the books, he says.
Continued in the article.
Examiner Raises More
By DAVID BARBOZA
September 22, 2002NYT
HOUSTON, Sept. 21 The Enron Corporation created a series of off-the-books partnerships that may have allowed the company to disguise billions of dollars in debt and to repeatedly manipulate its financial statements in recent years, the examiner in the company's bankruptcy case said in a report filed late Friday.
The preliminary report suggested that Enron, with the help of its former auditor, Arthur Andersen, violated accounting rules by creating a series of complicated financial transactions that often treated loans as sales that pumped up Enron's reported revenue, profit and cash-flow.
The report also found that Enron viewed many of these transactions as "balance sheet management," that they were not always arms-length transactions, and that many of the company's debts were not disclosed to investors.
According to legal experts and people involved in the bankruptcy case, these findings are the latest examples of how complicated structured-finance transactions may have allowed Enron to obfuscate its financial condition and possibly defraud investors of billions of dollars.
There are now more than a dozen federal investigations into the collapse of Enron, based in Houston, last December. Andersen, the giant accounting firm, has since failed. And recently, members of Congress have criticized some of the world's largest banks and brokerage firms, like Citigroup, J. P. Morgan Chase and Merrill Lynch, accusing them of engaging in deals that helped Enron manipulate its financial statements.
The examiner's findings are significant. If he determines that certain former Enron executives, accountants, financial institutions and law firms were responsible for Enron's collapse because of fraud, the court could appoint someone to file lawsuits and seek to recover billions of dollars in losses for the Enron estate.
In the report to the bankruptcy court in New York which appointed him examiner in the case, Neal Batson detailed six transactions in which Enron created partnerships and then sold an asset to that partnership to book income and revenue or cash flow. The transactions, the examiner said, do not appear to be real sales but disguised loans.
Mr. Batson, an Atlanta lawyer who has assembled a large team of investigators, has declined to speak to the news media. But in the 160-page report filed with the court late Friday, he said that he had not come to any firm conclusions. Yet he said that between 1997 and 2001, Enron raised $1.4 billion in cash through such deals.
Accounting experts have said that similar transactions suggest that Enron was often desperate for cash, particularly in 2000 and 2001, and that the company was seeking to raise money that it would not have to disclose to outside investors as debt. The company may have also found other ways of using the partnerships, the experts say, like bolstering its revenue, income and cash flow statements, as well as ridding itself of some poorly performing assets.
The deals were done with special purpose entities with names like Hawaii 125-0, Nikita, SO2, Backbone and Cerberus. And several of them involved other companies closely affiliated with Enron, like LJM2, which was run by Andrew S. Fastow, the company's former chief financial officer, and assets tied to Enron Oil and Gas, EOTT Energy Partners and NewPower Holdings, which were company spin-offs.
The deals also involved some of the world's biggest banks, including the Canadian Imperial Bank of Commerce, Barclays, FleetBoston Financial and Credit Suisse First Boston. Spokesmen for those banks were unavailable for comment late today. In the past, most of them have said their dealings with Enron were proper.
Some creditors hailed the preliminary findings of the report.
"The examiner's report underscores the complicity of the investment banks in Enron's collapse," said Andrew Entwistle, a lawyer who represents some of the creditors in the Enron bankruptcy case, said today. "The Wall Street banks used structure finance to aid and abet Enron's fraud."
In one complicated set of transactions mentioned in the report, for instance, Enron set up a partnership called Hawaii 125-0. Enron sold the partnership some of its assets in NewPower Holdings, including common stock. Enron agreed to pay Hawaii interest and fees to hedge the stock so that Enron could book $370 million in income in 2000, about 14 percent of its profits that year.
The examiner's experts believe several of the transactions with Hawaii were actually disguised loans. They were not true sales but Hawaii was paid to raise money for Enron by holding an asset Enron continued to control and benefit from, the report said. The examiner also said that Enron's debt was often improperly disclosed in its financial statements.
In the report, the examiner suggested that many of the deals were a sham. He said that Enron often set up the partnership and backed it with Enron's credit to help it obtain financing. Enron then sold the partnership an asset but often retained control of the asset and essentially made interest payments back to the partnership as part of the deal. Most of the time, the examiner said, the assets were difficult to sell or did not have sufficient cash flow to cover the partnership's purchase price.
"Enron intended the transfers of assets to be sales for financial reporting purposes," the examiner wrote. "On the other hand, the economic consequences to Enron of these transactions were substantially similar to loans."
Based on this preliminary study, the examiner wrote that if those sales are recharacterized as loans, about $500 million in assets that were sold to various partnerships could be the property of the debtor, or the Enron estate.
Over the past two years, the examiner said that Enron was prolific in the use of special purpose entities to raise money, and that around the time Enron filed for bankruptcy it listed about $13 billion as debt on the balance sheet but about $25 billion in off-balance-sheet debt, largely because of transactions like these.
The examiner also questioned why in some places Enron and its accountants reported gains on a reported sale but sometimes listed certain transactions as loans for tax purposes. The examiner, who has subpoena power and is seeking Enron-related documents from more than 400 other financial institutions and law firms, is expected to issue other reports in the coming months.
Among the questions he is seeking to answer, according to his report, are: what was the role of the special purpose entities in the collapse of Enron? And, if it is determined that wrongful acts were committed in those off-balance-sheet partnership transactions, can the estate sue former Enron executives, directors, lawyers, accountants and companies that helped bring down Enron?
AMERICAN STOCK EXCHANGE BOARD APPROVES ENHANCED CORPORATE GOVERNANCE RULES & REMITS TO SEC FOR REVIEW AND APPROVAL --- http://www.amex.com/atamex/news/press/sn_CorpGovRules_091302.htm
Note in particular the new rules pertaining to audit committees.
New York - The American Stock Exchange (Amex) Board of Governors formally approved enhanced rules that will increase disclosure requirements, strengthen board oversight and audit committee responsibility, and provide for increased shareholder rights for its listed companies.
"As a guardian of capital markets and proponent of innovation, our goal is to establish rules that ensure accountability, transparency and oversight while also recognizing the importance of the diversity and critical needs of companies at different stages of development," said Amex Chairman and CEO Salvatore F. Sodano. "The Amex has always been a regulator that is focused not only on strong regulation, but also focused on enhancing prospects for current and future economic prosperity."
The following measures have been approved by the Amex Board of Governors:
Ethics and Disclosure
Amex employees and floor members are prohibited from serving on the board of any Amex-listed company.
Each Amex-listed company must adopt and disclose a code of ethics and compliance program.
Each foreign Amex issuer must include summary disclosure regarding any material differences between home country corporate governance practices and Amex requirements in its annual proxy statement
Amex-listed companies will be required to make timely public disclosure of board changes and vacancies and auditor "going concern" opinions.
- Amex-listed companies must obtain shareholder approval of all stock option plans subject to limited exceptions, and brokers will not be permitted to vote their customers' shares on stock option plan proposals without instructions from the customer.
Board of Director Independence and Other Requirements
- Amex-listed companies must have boards comprised of a majority of independent directors, except for "controlled" companies and small business filers.
- The definition of "independent" will be tightened and the board of each listed company will be required to evaluate any relationship between a director and the company and make an affirmative determination that such relationship does not preclude a determination that the director is independent. Audit committee members will only be permitted to receive such fees from the listed company as are permitted by SEC rules pursuant to the Sarbanes Act.
- Amex-listed companies must hold board meetings on at least a quarterly basis.
- Independent directors must meet as often as necessary to fulfill their responsibilities, including in executive session without the presence of non-independent directors and management at least annually.
- Boards of Amex-listed companies may not be classified into more than three classes of directors, and each director's term of office may not exceed three years.
- Audit committee requirements will be conformed to the provisions and requirements of the Sarbanes Act.
- Audit committee chairs of Amex-listed companies must be financially sophisticated and all members of the audit committee must be financially literate at the time of appointment.
- Amex-listed company audit committees must be responsible for selecting the independent auditor and must meet privately with the independent auditor.
- Audit committees of Amex-listed companies must have the authority and funding to engage independent counsel and other advisors in appropriate circumstances.
- Amex-listed companies must hold audit committee meetings on at least a quarterly basis.
- The time that a non-independent director may serve on an Amex-listed company audit committee pursuant to the "exceptional and limited circumstances" exception will be limited to two years, and such director may not serve as chair of the committee.
- Audit committee and board composition requirements applicable to Small Business filers will be increased.
- All related party transactions entered into by Amex-listed companies must be subject to oversight by the audit committee.
Compensation and Nominating Committees
- CEO compensation must be approved by a compensation committee composed entirely of independent directors or by a majority of the independent directors on an Amex-listed company board (except for "controlled" companies). Other executive compensation must be subject to review by the compensation committee (or a majority of the independent directors) in consultation with the CEO, which will be responsible for making a recommendation to the board.
- Board nominations must be approved by a nominating committee composed entirely of independent directors or by a majority of the independent directors on an Amex-listed company board (except for "controlled" companies and nominations which are legally required by contract or otherwise).
- The Amex staff is authorized to issue a "warning letter" to a listed company for a minor corporate governance violation. Amex-listed companies will be required to make timely public disclosure of board changes and vacancies and auditor "going concern" opinions.
- It is anticipated that the requirements applicable to board and audit committee composition would become effective two years following the SEC approval of the proposed rule change, unless earlier implementation is otherwise required by SEC rules adopted pursuant to the Sarbanes Act. The other proposed changes would generally become effective within six months of SEC approval, or in the case of the disclosure requirements, sanctions and Amex employee prohibitions, immediately.
"These new rules further strengthen a marketplace whose foundation is built on integrity," continued Sodano. "Our enhanced rules strike the appropriate balance between strong investor protection and transparency, along with a marketplace that encourages innovation and agility."
The enhancements approved by the Amex Board of Governors will be presented to the SEC and are subject to review and approval.
From the AccountingWeb --- http://www.accountingweb.com/cgi-bin/item.cgi?id=91819
Gemstar's Dispute With KPMG Goes to SEC
AccountingWEB US - Sep-30-2002 - Faced with possible delisting by the NASDAQ Exchange, Gemstar-TV Guide announced last week that it is requesting guidance from the U.S. Securities and Exchange Commission (SEC) to resolve a dispute between its audit committee and its auditor, KPMG.
The dispute involves details of the company's financial results for the quarter ending June 30, 2002. On August 14, 2002, Gemstar said its audit committee has been conducting a review of the company's revenue recognition policies. Based on that review, management intended to reverse the recognition of approximately $20 million of revenues and $20 million of associated amortization expense. Both amounts relate to a non-monetary transaction of a subsidiary of TV Guide Inc.
According to Gemstar's announcement, KPMG has informed the company that it does not believe the information that had come to the audit committee's attention supports a change in the accounting treatment for this transaction. The firm also advised Gemstar that it will not be able to complete its SAS 71 review procedures until a final conclusion is reached regarding the restatement.
From the AccountingWeb --- http://www.accountingweb.com/cgi-bin/item.cgi?id=91819
FASB Issues FAS 147, Holds Roundtable on SPEs
AccountingWEB US - Oct-2-2002 - The Financial Accounting Standards Board (FASB) issued Statement No. 147 on "Acquisitions of Certain Financial Institutions" and held a roundtable discussion on accounting for special purpose entities (SPEs).
- FAS 147. Statement 147 fills in one of the gaps left when FASB issued Statements No. 141, "Business Combinations," and No. 142, "Goodwill and Other Intangible Assets." The new standard revises portions of Statement 72, which was developed as a "practical solution" to avoid creating reported earnings from purchase accounting in times when interest rates were at historical highs and many financial institutions were reporting losses. An article written by FASB practice fellow Brian Degano answers frequently asked questions about the project.
- SPEs. Separately, on September 30, FASB held a roundtable discussion on accounting for special purpose entities. According to press accounts, opinion was divided on the need for a speedy resolution of the matter versus the need for a thorough review of the issues. Securities and Exchange Commission (SEC) Deputy Chief Accountant Jackson Day stressed the need for speed. But Stephen Brookshire, managing principal of Atlantic Financial Group, likened the standard-setting initiative to "taking a bazooka to bird-hunting." Other concerns focused on the proposed effective date of March 15, 2003, which coincides with SEC filing deadlines for calendar-year companies, along with the potential need to consolidate an SPE, then later deconsolidate it due to a change in investors. ("SEC: Imperative to finalize new SPE accounting rules by year-end," Wall Street Journal, September 30, 2002.)
Bob Jensen's threads on SPEs are at http://www.trinity.edu/rjensen//theory/00overview/speOverview.htm
From wsjeducatorreviews on October 9, 2002
This site offers collection of articles with continuing coverage of corporate accounting issues that includes detailed information on what happened at Enron, Arthur Andersen, Tyco and WorldCom and other corporations. This collection makes clear how investor confidence was seriously eroded.
SPECIAL PAGE 2
Analyzing the Analysts
This site offers a collection of articles on criticisms of security analysts. Specifically, the articles in this collection point to analyst recommendations that benefit the analyst, the client of the analyst's firm, and the analyst's firm itself. These recommendations of course do not benefit the outside investor. Articles in this collection also point to regulatory and industry changes that have been proposed to solve the conflicts of interest. One proposed change is Citicorp's proposal to federal regulators to completely sever ties between its research and investment-banking businesses, and to pay a fine that could reach hundreds of millions of dollars.
Interactive Graphics Issues about Recent Scandals
Profit Warnings May Be Sign of Industry Woes
This article directly discusses the issue under consideration in this edition of the Interdisciplinary Review.
Merrill Fires a Vice Chairman for Refusal to Testify on Enron By Charles Gasparino 09/19/02
The article highlights two issues about Merrill Lynch's reputation as a brokerage firm, and its ability to provide reputable, correct information to securities traders. First, Merrill Lynch & Co. fired Thomas Davis, one of two corporate vice chairmen, for his refusal in an investigation by the Justice Department and the Securities and Exchange Commission into several questionable financial transactions Merrill completed for Enron in 1999. While Merrill has not uncovered any wrongdoing on the part of Mr. Davis, the company is enforcing its policy of requiring employees to fully cooperate with regulatory and law-enforcement investigations. Mr. Davis was questioned about his dealings with Enron, and the involvement of senior Wall Street officials in helping to create some of the partnerships that Enron used to pad its earnings and hide debt from investors. Second, at issue for Merrill is the potential for conflicts of interest. Merrill, like some other Wall Street firms, wore a number of different hats with Enron. The big securities firm acted at various times a securities underwriter and investor with Enron. Moreover, the personal investments of some Merrill employees with Enron entities may have interfered with their business decisions in dealing with the energy company.
Tyco Probe Expands to Include Auditor PricewaterhouseCoopers
By Mark Maremont and Laurie P. Cohen
ARTICLE URL: http://online.wsj.com/article/0,,SB103333684988087833.djm,00.html
New York prosecutors are investigating whether Tyco International's outside auditor, PricewaterhouseCoopers, may have known about secret bonuses paid to former Tyco executives. A related line of investigation by prosecutors is whether PricewaterhouseCoopers auditors were aware that Tyco's annual proxy filings were incorrect but failed to do anything about it. Lynn Turner, a former chief accountant at the Securities and Exchange Commission who also reviewed the filing, went even further, saying "this is called fraud." As for the auditors, he asked: "How the hell do you do that and not have PricewaterhouseCoopers find it?" Mr. Turner said auditors typically look closely at such items as tax accounts and big one-time gains, and should have spotted the bonus payments tucked in there.
Enron Creditors Get Approval For Suit Against Ex-Executives
By Mitchell Pacelle and Katheryn Kranhold
As prosecutors prepared to file a criminal complaint against Enron Corp.'s former CEO, Andrew Fastow, the company's creditors secured permission to sue Mr. Fastow and a slew of other senior executives, including former Chairman Kenneth Lay and former Chief Executive Jeffrey Skilling. The suits will accuse the former executives of breach of fiduciary duty, fraud, and gross negligence, among other things.
"This is just the beginning of the lawsuits," said Enron's lead bankruptcy lawyer. "The ones who will be gone after are the ones who harmed Enron. They should have to pay back some of the harm they did.
Earlier this year, Enron's committee of unsecured creditors issued more than 70 subpoenas to individuals and companies as part of its investigation into claims Enron and its creditors may bring. The committee determined certain directors, officers and employees "engaged in wrongdoing and misconduct."
Separately, Enron's shareholders and employees have brought securities-fraud litigation against Arthur Andersen, Enron's auditor, as well as Enron's bankers and law firms.
1. Accounting. What role should the accounting profession play in restoring confidence? Should public accounting firms take the lead, with the support from the SEC, and call for all accounting regulations to be interpreted in a conservative light and in their auditing role hold public corporations more accountable for correctly following regulations, even at the risk of losing accounts?
Andersen gets stomped upon once again, although the September 24 announcements seem to be added on to a lawsuit commenced in June. However, the amount seems to have increased from $100 million to $1 billion. What do you think the odds are for collecting from Andersen? --- http://biz.yahoo.com/iw/020606/043133.html
Software company Peregrine Systems Inc., the self-described leading global provider of Infrastructure Management software, filed for Chapter 11 bankruptcy projection over the weekend and announced plans to file a lawsuit seeking at least $1 billion from Arthur Andersen LLP, Arthur Andersen Worldwide, Arthur Andersen Germany, and Andersen audit partner Daniel Stulac --- http://www.accountingweb.com/item/91308
Note that on the Peregrine audit, KPMG replaced Andersen last spring.
Peregrine Systems, Its Auditor And Senior Management Named In Lawsuit For Improper Accounting Of Over $100 Million, Brought By The Law Firm Of Harvey Greenfield
NEW YORK, NY--(INTERNET WIRE)--Jun 6, 2002 -- The Law Firm of Harvey Greenfield announces that a class action lawsuit was filed on behalf of purchasers of the securities of Peregrine Systems, Inc. ("Peregrine" or the "Company") (NASDAQ:PRGN - news) between July 21, 1999 and May 3, 2002, inclusive. A copy of the complaint filed in this action is available from the Court or can be obtained from the counsel listed below.
The action is pending in the United States District Court, Southern District of California against the Company, the Company's former auditor Arthur Andersen LLP, and two of the Company's former officers.
The complaint alleges violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 by, among other things, improperly accounting for over $100 million by booking revenue from indirect sales channels, in violation of Generally Accepted Accounting Principles ("GAAP"), thereby leading to a material overstatement of the Company's revenues.
On May 6, 2002, Peregrine announced that it would be forced to take a $100 million restatement, "for periods in fiscal 2002 and prior" to account for "certain transactions involving revenue recognition irregularities," and that, as a result, the Company's CEO and CFO would both resign. That day, the stock, which had traded as high as $38.25 during the class period, plunged to close at $0.89 a share. This announcement followed Peregrine's replacement of its long time auditors, Arthur Andersen LLP with KPMG.
Thereafter, on May 23, 2002, Peregrine announced that it would restate financials back to fiscal 2000. It also announced that the Securities & Exchange Commission ("SEC") was conducting an investigation into Peregrine's accounting practices.
If you bought the securities of Peregrine between July 21, 1999 and May 3, 2002, you may, no later than July 8, 2002 request that the Court appoint you as lead plaintiff. A lead plaintiff is a representative party that acts on behalf of other class members in directing the litigation. In order to be appointed lead plaintiff, the Court must determine that the class member's claim is typical of the claims of other class members, and that the class member will adequately represent the class. Under certain circumstances, one or more class members may serve together as "lead plaintiff." Your ability to share in any recovery is not, however, affected by the decision whether or not to serve as a lead plaintiff.
If you wish to discuss this action with us, or have any questions concerning this notice or your rights and interests with regard to the case, please contact Harvey Greenfield at The Law Firm of Harvey Greenfield, 60 East 42nd Street, Suite 2001, New York, NY, 10165; telephone (212) 949-5500; fax (212) 949-0049; or email email@example.com.
Although recent legislative accounting reforms have focused on public companies, the fallout from corporate greed has also affected executives of private companies. Last week, a former CEO got 3 years in jail for tax evasion. http://www.accountingweb.com/item/91302
AccountingWEB US - Sep-24-2002 - Although recent legislative reforms have focused on public companies, headlines show the fallout from corporate greed also affects executives and auditors of private companies. Last week, the founder and former CEO of Conair Corporation was sentenced to 20 to 37 months in jail for tax evasion.
The tax evasion took the form of a multi-million dollar kickback scheme involving several vendors. The vendors were directed to falsely inflate the service fee they charged the company for shipping containers from Hong Kong to the U.S. The difference was kicked back into the CEO's Swiss bank accounts or to people, charities or companies he designated.
The scheme resulted in $3 million in unreported income on the owner's individual tax return. Last week, he paid the Internal Revenue Service (IRS) almost $2 million to cover his federal tax liabilities. The company paid more than $3.6 million to cover its federal civil tax liabilities. The company's annual sales are estimated at $500 million to $1 billion.
Continued at http://www.accountingweb.com/item/91302
Panda Cam (From the San Diego Zoo) --- http://www.sandiegozoo.org/special/pandas/pandacam/
From the Risk Waters Group on September 27, 2002
The four most senior financial regulators in the US have joined forces to express concern at legislative proposals to expand regulation of over-the-counter energy derivatives. The move comes as Senate agriculture chairman Tom Harkin, a Democrat from Iowa, and Republican senator Richard Lugar, from Indiana, are drafting legislation that would expand upon Californian Democrat senator Dianne Feinstein's OTC energy regulation proposals that were defeated in February on a routine procedural vote. Federal Reserve chairman Alan Greenspan, Treasury secretary Paul O'Neill, Securities and Exchange Commission chairman Harvey Pitt and Commodity Futures Trading Commission chairman James Newsome said in a letter that the Harkin and Lugar proposal to subject market participants to disclosure of proprietary trading information is unwarranted.
Week Cover Story
THE BEST & WORST BOARDS
Across Corporate America, a governance revolution is under way. Top execs who once dismissed criticism of their conflict-ridden boards are scrambling to reform -- because investors now shy away from companies where oversight is lax. This Cover Story examines the progress U.S. corporations are making -- including which boards are most improved and which still need work. For BW subscribers :
For all as of September 30, 2002 :
From the October 4, 2002 edition of The Wall Street Journal Accounting Educators' Review
TITLE: Tyco Probe Expands to Include
Auditor Pricewaterhouse Coopers
REPORTER: Mark Maremont and Laurie P. Cohen
DATE: Sep 30, 2002
TOPICS: Accounting Fraud, Accounting Irregularities, Accounting, Accounting Law, Audit Quality, Auditing, Executive compensation, Legal Liability
SUMMARY: Prosecutors have charged former Tyco executives with taking unauthorized compensation and gaining from illegal stock sales. Tyco's auditor, PricewaterhouseCoopers, is now being questioned about the matter. Questions focus on auditor responsibilities and legal liability.
1.) Describe the accounting that was used to hide the unauthorized compensation payments that were made to Tyco executives. What is the proper accounting treatment for executive compensation? Were the financial statements misstated? Support your answer.
2.) What is an auditor's responsibility for detecting illegal acts? Does the payment of unauthorized compensation constitute an illegal act? Support your answer.
3.) What is materiality? Does the payment of unauthorized compensation constitute a material event? Did the accounting for the unauthorized payments have a material effect on the financial statements? Support your answers.
4.) If PricewaterhouseCoopers is prosecuted for failing to detect and report the improper accounting at Tyco, what defenses are available? Discuss the likelihood that PricewaterhouseCoopers could successfully defend itself.
Reviewed By: Judy Beckman, University
of Rhode Island
Reviewed By: Benson Wier, Virginia Commonwealth University
Reviewed By: Kimberly Dunn, Florida Atlantic University
From the October 4, 2002 edition of The Wall Street Journal Accounting Educators' Review
TITLE: For EDS Chief, Some Gambles That
Fueled Growth Turn Sour
REPORTER: Elliot Spagat, Ken Brown, and Gary McWilliams
DATE: Oct 01, 2002
TOPICS: Financial Accounting, Revenue Recognition
SUMMARY: EDS has booked "large chunks of revenue before it has been received or even billed" under long term contracts with customers. Collectibility of these receivables, and the propriety of the contract accounting, is now in question because of certain large customers' bankruprtcy filings and because of contract repricing guaratees EDS has made.
1.) Describe the nature of EDS's operations. What are they selling? Why must they invest large, up front costs when undertaking a contract?
2.) How do you think EDS is accounting for the revenue under its long term contracts with customers? (Hint: you can verify this method by going to the company financials found on its web site at http://www.eds.com/01annual/.) What accounting standards and other authoritative literature establish the methods that must be used to recognize this revenue?
3.) "For one thing, though the contracts are long-term, the pricing often isn't." How does this statement impact the accounting for these contracts?
4.) What is likely to happen to EDS?'s receivables under the contracts with WorldCom and US Airways, two companies that are in bankruptcy court now? Should these circumstances with these particular companies affect the way that EDS accounts for its long term contracts with customers in general?
5.) Note that the issues regarding EDS's stock option plan that are mentioned in this article were covered in the Educators' Review dated September 27, 2002. The article that was the subject of that review is listed under Related Articles.
Reviewed By: Judy Beckman, University
of Rhode Island
Reviewed By: Benson Wier, Virginia Commonwealth University
Reviewed By: Kimberly Dunn, Florida Atlantic University
--- RELATED ARTICLES ---
TITLE: EDS Makes Losing Bet on Stock, Raising Concern About Liquidity
REPORTERS: Elliot Spagat and Gary McWilliams
ISSUE: Sep 25, 2002
Bob Jensen's threads on revenue reporting are at http://www.trinity.edu/rjensen/ecommerce/eitf01.htm
September 29, 2002 message from Derek Speer [d.speer@AUCKLAND.AC.NZ]
A small-scale variant on "round-tripping" has recently been exposed in New Zealand. By law in this country bars may not make a profit from gaming machines, such profits must be donated to charity. A genuine, high-profile charitable organisation trust struck a deal with many bar owners. In exchange for being the preferred charity the trust agreed to rent billboard space from the bar owner. The billboards were erected but by a strange coincidence the rental always amounted to 50% of the bar's gaming machine profits, and was many times the market rental cost of equivalent billboard space. As far as the bars were concerned what would have been illegal income was given away and returned as legal income. The scheme was discovered when someone started investigating why the trust's publicity costs had leapt over previous years and the investigation is ongoing.
The University of Auckland
Bob Jensen's threads on revenue round tripping are at http://www.trinity.edu/rjensen/ecommerce/eitf01.htm#RoundTripping
The Warren Buffett Business Factors, free internet book. (Selected articles from the Letters of Warren E. Buffett to the Shareholders of Berkshire Hathaway Inc.) --- http://www.frips.com/wbbf.htm
My new and updated documents the recent accounting and investment scandals are at the following sites:
Bob Jensen's threads on the Enron/Andersen scandals are at http://www.trinity.edu/rjensen/fraud.htmBob Jensen's SPE threads are at http://www.trinity.edu/rjensen//theory/00overview/speOverview.htmBob Jensen's threads on accounting theory are at http://www.trinity.edu/rjensen/theory.htm
Bob Jensen's Summary of Suggested Reforms --- http://www.trinity.edu/rjensen/FraudProposedReforms.htm
Bob Jensen's Bottom Line Commentary --- http://www.trinity.edu/rjensen/FraudConclusion.htm
The Virginia Tech Overview: What Can We Learn From Enron? --- http://www.trinity.edu/rjensen/fraudVirginia.htm
March 2000, Forbes named AccountantsWorld.com as the Best Website on the
Web --- http://accountantsworld.com/.
Some top accountancy links --- http://accountantsworld.com/category.asp?id=Accounting
For accounting news, I prefer AccountingWeb at http://www.accountingweb.com/
Another leading accounting site is AccountingEducation.com at http://www.accountingeducation.com/
Paul Pacter maintains the best international accounting standards and news Website at http://www.iasplus.com/
How stuff works --- http://www.howstuffworks.com/
Jensen's video helpers for MS Excel, MS Access, and other helper videos are at http://www.cs.trinity.edu/~rjensen/video/
Accompanying documentation can be found at http://www.trinity.edu/rjensen/default1.htm and http://www.trinity.edu/rjensen/HelpersVideos.htm
Robert E. Jensen (Bob) http://www.trinity.edu/rjensen
Jesse H. Jones Distinguished Professor of Business Administration
Trinity University, San Antonio, TX 78212-7200
Voice: 210-999-7347 Fax: 210-999-8134 Email: firstname.lastname@example.org