Accounting Scandal Updates on October 30, 2002
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 

The FASB is looking for your advice on whether to dim the bright lines in accounting standards and move to a "principles-based" approach that leaves financial reporting choices much more in the hands of professional judgment of management and their auditors --- http://www.fasb.org/proposals/principles-based_approach.pdf 

The main arguments for principles-based standards are that they will be less complex and will lead to less game playing (such as when firms purchase19.99% of the equity in another company rather than 20% in order to avoid the equity method of accounting under FAS 115 and 124.)  But, in my viewpoint, principles-based standards are a disaster.

Anybody that thinks that principles-based standards will reduce the chances for Enron-like scandals is also willing to vote that there will be total peace on earth without first destroying most of mankind.  Some naive theorists point to international IASB standards before the IASB (formerly IASC) started adding bright lines to newer standards.  But IASB standards tend to avoid controversial issues, and even if there are some newer principles-based standards on controversial issues, such standards will not do much to improve  transparency in financial reporting.  International standards have been a bad joke, because international accounting standards are rarely enforced.  Many major nations like Germany do not even have an infrastructure for enforcing any type of accountancy standards, including their own standards and/or IASB standards.  International standards are selectively followed and avoided at will, and virtually no pressure is brought to bear on corporations to follow all international standards.  In the U.S., pressure is much greater to follow FASB accounting standards, because the U.S. is a litigious society with plaintiff attorneys armed with the bright lines of accounting and auditing standards (although the AICPA has tended to avoid some badly needed bright lines in auditing standards).

Principles-based standards are favored by accounting firms and corporate auditing clients, because such standards will make it much more difficult for investors to sue for damages attributed to misleading financial reporting.  In these troubled times when accounting firms are trying to restore their reputations and corporations are trying to restore confidence among equity investors, each move toward principles-based standards is a step backwards.  This is a time to get tough with auditing and accounting standards.  Unfortunately, hopes of reform of auditing standards in the U.S. were badly dashed by recent evidence that corporations and large accounting firms virtually own the SEC and the AICPA.  I am referring in particular to how obvious it became that the Big 4 firms, with the help of the AICPA leadership, stacked the new Public Company Accounting Oversight Board.   Anybody who believes that SEC Chairman Harvey Pitt is "fiercely independent" is probably also in favor of principles-based standards.  The selection process was most certainly not in the best interest of investors.  Newsweek reported the following on October 24, 2002 --- http://www.msnbc.com/news/826101.asp?0si=- 

SEC Chairman Harvey Pitt was joined by fellow Republicans Cynthia Glassman and Paul Atkins in voting for Webster and the other four board members. Democrats Harvey Goldschmid and Roel Campos voted against Webster. And while the vote was officially for all five accounting board members, Campos added he was voting for all but Webster.

In an unusually rancorous SEC open meeting, Pitt rejected suggestions he had been swayed by the accounting industry to support Webster over Biggs, saying he was “fiercely independent” and “beholden to no one.” But Goldschmid criticized the selection process as inept. “Until this morning, for example, I was not informed as to which 5 individuals would be presented to this commission at this meeting. To my knowledge, none of the individuals have been properly vetted,” he said.

I think Goldschmid's statement is incorrect.  Chairman Pitt, with the aid of corporate lobbyists adamantly opposed to the appointment of John Biggs, carefully vetted the slate of candidates that he (Pitt) intentionally selected to inhibit major reforms and bright lines in the best interest of investors. It was typical smoke and mirror politics in Washington DC.   Outwardly there seemingly was a glimmer of hope for reform that, when push came to shove, was dashed by powerful lobbyists.

November 6, 2002 Update:  Harvey Pitt resigned from the SEC on November 5.

Europe also has huge accounting problems! 
Europe Wants Increased Financial Disclosure --- http://www.smartpros.com/x35695.xml 

Reply from Elliot Kamlet SUNY Account [ekamlet@BINGHAMTON.EDU] 

I think it's even worse. John Biggs is sitting in his job at TIAA-CREF. One day Harvey Pitt comes to his doior to inform him he's number one for the leadership of the new Board and he'd better prepare. So he quits his job (and gets replaced immediately) and submits himself for nomination. Then Pitt said "who me? I never offered him the job" (not a direct quote). The rest Bob has shared with us. It's the pitts.

Elliot Kamlet 
Binghamton University

Book Recommendation: 
Title:  Take On the Street: What Wall Street and Corporate America Don't Want You to Know, 
Authors:  Arthur Levitt and Paula Dwyer (Arthor Levitt is the highly controversial former Chairman of the SEC)
Format: Hardcover, 288pp.  This is also available as a MS Reader eBook --- http://search.barnesandnoble.com/booksearch/ISBNinquiry.asp?userid=16UOF6F2PF&isbn=0375422358 
ISBN: 0375421785
Publisher: Pantheon Books
Pub. Date: October  2002
See http://search.barnesandnoble.com/booksearch/isbnInquiry.asp?userid=16UOF6F2PF&isbn=0375421785 

This is Levitt's no-holds-barred memoir of his turbulent tenure as chief overseer of the nation's financial markets. As working Americans poured billions into stocks and mutual funds, corporate America devised increasingly opaque strategies for hoarding most of the proceeds. Levitt reveals their tactics in plain language, then spells out how to intelligently invest in mutual funds and the stock market. With integrity and authority, Levitt gives us a bracing primer on the collapse of the system for overseeing our capital markets, and sage, essential advice on a discipline we often ignore to our peril - how not to lose money. http://www.amazon.com/exec/obidos/ASIN/0375421785/accountingweb 

A free video from Yale University and the AICPA (with an introduction by Professor Rick Antle, also Senior Associate Dean, from Yale).  This video can be downloaded to your computer with a single click on a button at http://www.aicpa.org/video/ 
It might be noted that Barry Melancon is in the midst of controversy with ground swell of CPAs and academics demanding his resignation vis-a-vis continued support he receives from top management of large accounting firms and business corporations.

A New Accounting Culture
Address by Barry C. Melancon
President and CEO, American Institute of CPAs
September 4, 2002
Yale Club - New York City
Taped immediately upon completion

Using Technology to Reduce Fraud --- http://www.smartpros.com/x35666.xml 

Oct. 21, 2002 (Internet World) — These are not the best of times to be sitting in the chief executive's chair of a lot of companies. If a bear market weren't bad enough, chief executives are being put directly in the bull's eye of public and political ire over financial accounting scandals that at their worst have sucked billions of dollars out of the market, and at the least have depressed the market rebound.

That pressure will be felt far beyond just the 947 public companies whose CEOs and CFOs have been forced by the Securities and Exchange Commission to certify the truthfulness of their financial reports. And though that move by the SEC was largely a publicity stunt (you can even go to the SEC's Web site and view the sworn statements from these executives), the question arises about whether technology can play a part in providing protection for investors and company executives.

"It's quite an interesting topic," says Kraig Haberer, a former CPA at Price Waterhouse who now serves SAP AG as director of product marketing for its mySAP Financials suite. "Technology can be an enabler; however, it cannot replace good judgment." He notes that the situations that have blackened corporate images today are primarily caused, not by a lack of technology, but by bad judgement by a few key executives.

"However, I do think technology can help minimize the chance of occurrences of either outright fraud or purely overlooking something in an account," Haberer says. "To some degree, the more automated you can make your processes and your financial reporting and accounting, the better off you are because technology can be that independent third party. You have a lot of companies with multiple data feeds they are pulling from. That process of recording, processing, and reporting on that information is not automated, and you can introduce the likelihood of just pure error, nothing fraudulent. So technology can be that third party that can automate and integrate that process and minimize the opportunities for error."

The mySAP response is to give the finance department a number of automated tools for handling the complexity of financial reporting in the modem global enterprise. That can make it more difficult for an unscrupulous person somewhere in the mix to introduce unethical practices, but it still may not be enough to let the CEO relax. "You also have to empower that chief officer with the information at his desk," Haberer says. MySAP offers an executive dashboard, where you can specify the key indicators you want to track at a high level and see their performance over time. Simply by having lowerlevel executives know they're being watched may not eliminate the threat, but if you sense a problem, you will at least know what questions to ask.

To others, the problem is a security matter related to protecting the integrity of the data in the enterprise's financial systems. In August, Datum Inc. and WetStone Technologies Inc. jointly announced a new subscription service, called Time Lock for Microsoft Word that lets users embed secure and auditable digital time stamps into their work. They then have a document that can be verified for authenticity and time accuracy.

"If I was a CEO of a company and I had to sign off on the financial statements, I would want to know that my records are absolutely protected," says Steve Corie, who is in fact the CEO and president of a company, Perimeter Data Inc. Perimeter recently began selling a product that takes Datum's idea to its logical conclusion: it makes it so that any files-email, video, a series of sequential documents, voice mail, etc.-are stamped, signed, and archived in a way that makes it impossible to delete or modify. "CEOs have a fear, that if they do sign off on something, they have to rely on people down the organization," he adds.

For Comrie, the key point is that the data is viable and can be proven legally in a court of law, if necessary. He sees a future in which a brokerage house under investigation might say certain e-mails being sought by investigators have been deleted or don't exist, but their auditor steps in with the records it keeps from its collaboration with its brokerage client, and produces the digitally signed, time stamped, and sealed files. That might actually create a headache for an unscrupulous chief executive, but that headache, at least, would be well deserved.

"There's no way even an administrator with access can go in and delete or manipulate data" with Perimeter's system, says Comrie. "We believe there is a vulnerability most corporations will never talk about, that at the end of the day some of this stuff will be challenged in a court of law-some will be brought forward as evidence."

The ultimate answer for corporate financial accountability is not technological, of course. If a company's executives or directors are concerned about their financials, the answer lies in the integrity of the people managing the financial records. But company leaders can invest in certain technology that can help them detect problems before they become disastrous headaches, whether the problem was man-made or a simple result of people tripping over too-complex financial regulations.

-- Zipperer, John

The MySAP Solutions homepage is at http://www.sap.com/solutions/ 

mySAP.com delivers a comprehensive e-business platform designed to help companies collaborate and succeed -- regardless of their industry or network environment. mySAP.com solutions include:

 

mySAP.com Solutions
	Industry Solutions Solutions for Small and Midsize Businesses mySAP Enterprise Portal mySAP Supply Chain Mgmt. mySAP Customer Relationship Mgmt. mySAP Supplier Relationship Mgmt. mySAP Product Lifecycle Mgmt.	mySAP Marketplace mySAP Business Intelligence mySAP Financials mySAP Human Resources mySAP Mobile Business mySAP Technology

Flexible Solutions for Any E-Business Problem
mySAP.com solutions are open and flexible, supporting databases, applications, operating systems, and hardware platforms from most major vendors. They also uphold the highest quality standards and deliver unparalleled levels of performance. And they're appropriate for virtually any organization, from global enterprise to small and midsize business.

What's more, SAP provides Business Maps to help you visualize, plan, and implement a coherent, integrated, and comprehensive solution.

To learn more about the mySAP.com e-business platform, check out "Solutions for the Best-Run E-Businesses" (PDF, 643 KB).

To find out how some of SAP's most successful customers are using mySAP.com to improve their businesses, check out "SAP E-Business Success Stories 2001 Edition" (PDF, 238 KB).

Want to learn more? Contact SAP for additional information.

Bob Jensen's threads on electronic commerce can be found at http://www.trinity.edu/rjensen/ecommerce.htm 

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

An Important 272 Page Report from the GAO that documents major post-audit restatements of earnings by corporations for the Year 2001
FINANCIAL STATEMENT RESTATEMENTS Trends, Market Impacts, Regulatory Responses, and Remaining Challenges
United States General Accounting Office , GAO 03-138, October 2002 --- http://www.gao.gov/new.items/d03138.pdf 
(Includes a glossary of key terms.)

While the number of restating companies continues to make up a small percentage of all publicly listed companies annually, the number of restatements due to accounting irregularities grew significantly—about 145 percent—from January 1997 through June 2002. Based on the number of restatements as of June 30, 2002, we expect the increase to exceed 170 percent by the end of the year. The number of financial statement restatements identified each year rose from 92 in 1997 to 225 in 2001. The proportion of listed companies on NYSE, Amex, and Nasdaq identified as restating their financial reports tripled from less than 0.89 percent in 1997 to about 2.5 percent in 2001 and may reach almost 3 percent by the end of 2002. From January 1997 through June 2002, about 10 percent of all listed companies announced at least one restatement. Among the restating companies that we identified, the number of large company restatements had grown rapidly since 1997. 6 The average (median) size by market capitalization of a restating company increased from $500 million ($143 million) in 1997 to $2 billion ($351 million) in 2002. 7 In addition, of the 125 public companies that announced restatements due to accounting irregularities in 2002, 54 were listed on Nasdaq and 53 were listed on NYSE, which generally lists more large companies than any other stock market.

The 845 restating companies we identified had restated their financial statements for many reasons—for example, to adjust revenue, costs or expenses, or to address securities-related issues. From January 1997 to June 2002, issues involving revenue recognition (misreported or nonreported revenue) accounted for almost 38 percent of the 919 announced restatements; revenue recognition was also the primary reason for restatement each year. Finally, in reviewing the restatements, we found different parties can prompt a restatement, including the restating company, an external auditor, or SEC. 

The 689 publicly traded companies we identified that announced financial statement restatements between January 1997 and March 2002 lost billions of dollars in market capitalization in the days around the initial restatement announcement. For example, from the trading day before through the trading day after an initial restatement announcement, stock prices of the restating companies that we analyzed fell almost 10 percent on average (market adjusted). We estimate that the restating companies lost about $100 billion in market capitalization, which is significant for the companies and shareholders involved but represents less than 0.2 percent of the total market capitalization of NYSE, Nasdaq, and Amex. However, these losses had potential ripple effects on overall investor confidence and market trends. Restatements involving revenue recognition led to greater market losses than other types of restatements. For example, although restatements involving revenue recognition accounted for 39 percent of the 689 restatements analyzed, over one-half of the total immediate losses were attributable to revenue recognition-related restatements. Although longer-term losses (60 trading days before and after) are more difficult to measure, there is some evidence that restatement announcements appear to have had an even greater negative impact on stock prices over longer periods.

The growing number of restatements and mounting questions about certain corporate accounting practices appear to have shaken investors’ confidence in our financial reporting system. Although determining the effect of financial statement restatements and other accounting issues on overall investor confidence is difficult to measure (because so many factors go into making investment decisions), various attempts to measure investor confidence have been made. For example, a UBS/Gallup survey-based index that asks questions aimed at measuring investor confidence indicates that people cited accounting practices as a serious problem and that these practices have negatively impacted securities markets.9 However, Yale University calculates four survey-based indexes that ask different questions that generally indicate that investor confidence in the markets has been largely unaffected as of June 2002. 10 Other sources such as empirical research studies and academic experts generally suggest accounting issues have negatively affected overall investor confidence and raised questions about the integrity of U.S. markets. 

With the increase in the number of restatements due to accounting irregularities, almost 20 percent of SEC’s enforcement cases since the late 1990s were for violations resulting from financial reporting and accounting practices. An SEC official said that about half of these enforcement cases involved revenue recognition violations. Of the 150 accounting-related cases brought from January 1, 2001, to February 28, 2002, about 75 percent were brought against public companies or their directors, officers, and employees; the other 25 percent of the cases involved accounting firms and certified public accountants (CPA). To address such violations, SEC has sought a variety of penalties against these companies and individuals, including levying monetary sanctions, issuing cease-and-desist orders, and barring individuals from appearing before SEC or serving as officers or directors in public companies.11 Slightly more than half of the enforcement proceedings initiated were administrative, involving allegations that a firm or individual had violated GAAP or that an individual had caused a firm or other individuals to act unlawfully. The remainder of the enforcement proceedings initiated were civil judicial actions, usually cases involving securities fraud. 

The recent increase in the number and size of financial statement restatements and disclosures of accounting issues and irregularities underlying these restatements have raised significant questions about the adequacy of the current system of corporate governance and financial disclosure oversight. In addition to public companies, their auditors, and SEC, investors rely on a variety of parties for oversight and financial information, including stock markets, securities analysts, and credit rating agencies, all of which have roles in the corporate governance system or provide information to the investing public. However, recent events have raised concerns about the roles played by each of these parties. In response, Congress, the President, SEC, the exchanges, and others have begun taking action to attempt to strengthen corporate governance and financial reporting. Most significantly, on July 30, 2002, the Sarbanes-Oxley Act was enacted.12 The act addresses many of these concerns, including strengthening corporate governance and improving transparency and accountability to help ensure the accuracy and integrity of the financial reporting system. In addition, the act authorizes additional funding for SEC, which as we reported in March 2002, has faced staffing and workload imbalances that have challenged its ability to fulfill its mission.13 Effectively managing its human capital resources, technology, and processes is likely to remain a challenge for SEC in the future, especially for regulatory activities involving oversight of public company disclosures and financial fraud-related enforcement.

Employees who try to bring to light unethical or illegal practices by their employers are often criticized, treated like outcasts, fired, or worse.
CFO.com --- http://www.cfo.com/article/1,5309,7778,00.html 

By Gary Silverman and Adrian Michaels in New York 
Business Week, November 2 2002 

A US banking regulator on Friday filed a $2bn suit against Ernst & Young for its role in a bank failure, saying the firm covered up improper accounting work so it could "buy time" for the sale of its consulting arm to Cap Gemini of France.

The suit filed by the Federal Deposit Insurance Corporation stems from the failure of Superior Bank, based in the Chicago suburb of Hinsdale, Illlinois, in July 2001. The failure cost the FDIC $750m.

Superior specialised in making mortgage loans to customers with tarnished credit histories - so-called "subprime" borrowers. It then used the expected cash flows from the loans to back bonds that were sold to investors.

Such business models - involving what is known as securitisation - have proved dangerous because the lender books its profits based on its estimate of expected returns. If borrowers fail to pay as much as expected - either through default or prepayment - the lender's earnings disappear, making proper accounting crucial.

The FDIC said Superior Bank failed "as a direct result of E&Y's gross mistatement of Superior's assets."  It said E&Y knew its work was "improper and grossly misleading" and failed to disclose that fact because it was trying to sell its consulting practice to Cap Gemini.

"E&Y's fraud went to the highest level of E&Y - its national office in New York," the FDIC's complaint said.
The complaint said the E&Y's auditing arm brought in its consulting division "to give the appearance of an independent, conservative and reasonable review of the valuation of Superior's securitisation assets." It added: "The 'review', however, was designed from the outset to be cursory in scope."
The complaint said: "Over the last approximately 11 years, E&Y has engaged in a pattern of repeatedly failing to adhere to established accounting and auditing standards."

E&Y said the FDIC complaint "flies in the face of the agency's own earlier conclusions". It said the FDIC had told legislators in February that Superior's failure was "directly attributable" to the bank's board and executives ignoring sound risk management principles.

E&Y has already been in trouble with lawsuits and regulatory scrutiny over its role as auditor to CUC, which later became Cendant. It has paid $335m to settle shareholder litigation in connection with fraud at the franchising and marketing group.
The lawsuit comes as public confidence in the audit profession has sunk to an all-time low. Andersen's role in the Enron scandal led to a federal criminal trial and its collapse. E&Y is one of only four global accounting firms left.

Lawsuits: I Wouldn't Cook Books So I Got Fired --- http://www.smartpros.com/x35618.xml 

Oct. 15, 2002 (USA TODAY) — As the crackdown on corporate fraud continues, some executives are suing their former companies, saying they were fired after refusing to cook the books.

---

There's no nationwide tally of such lawsuits. But with so much shady accounting and pressure to meet Wall Street numbers in recent years, attorneys say more corporate executives and whistle-blowers are striking back and not taking the fall for higher-ups.

Some cases are pending in:

* Silicon Valley. Ronald Sorisho, a former vice president at high-tech contractor Solectron in Milpitas, Calif., says in a lawsuit filed last week that he was canned because he believed the firm should have written down $45 million in obsolete inventory.

But executives refused to allow the write-down, saying it would hurt the firm's earnings and stock price, the lawsuit alleges.

Solectron spokesman Kevin Whalen denies the allegations, calling them "baseless" and "sour grapes." Sorisho was let go for poor performance, he says.

* Hollywood. A former executive hired by fallen super-agent Michael Ovitz sued him last week, alleging she was let go because she told auditors that Ovitz's Artists Management Group was misusing $4 million in annual funds from partner Vivendi.

Cathy Schulman, who ran Ovitz's film-production unit, charges that Ovitz fired her "in a rage" and engaged in a "public smear campaign" against her.

Ovtiz's attorney, Terry Sanchez of Munger Tolles & Olson in Los Angeles, declined to comment Friday.

* Texas. Bradley Farnsworth, the former controller at Dynegy, sued the Houston energy firm in August. He alleges he was dismissed because he would not manipulate natural-gas trading data and earnings.

Dynegy spokesman John Sousa says the company will investigate the allegations and prove them false.

Dynegy says Farnsworth never raised red flags with the company's board or audit committee, and he signed off on financial statements for fiscal 2000.

Dynegy's accounting practices are under investigation by the Justice Department and the Securities and Exchange Commission.

In recent months, former executives and managers at Xerox, WorldCom and Global Crossing have filed similar lawsuits alleging wrongful termination.

A new federal law may encourage more whistle-blowers to speak up. It requires companies to set up confidential procedures for employees who suspect fraud, and it allows workers to sue if they are harassed, demoted or fired for reporting allegations.

"This gives employees a decent weapon," says Jonathan Ben-Asher, an attorney at the law firm of Beranbaum Menken Ben-Asher & Fishel in New York. "We're going to see many more of these cases."

October 14, 2002 message from Dee (Dawn) Davidson [dgd@MARSHALL.USC.EDU] 

Bob Jensen's commentary on whistle blowing can be found at http://www.trinity.edu/rjensen/FraudConclusion.htm 

"Insider Loans: Everyone Was Doing It It isn't just the Enrons and the Tycos of the world that will eat huge losses on insider loans. It turns out that the practice -- now banned -- was common at 75 percent of the country's biggest corporations," by Ralph King, Business 2.0, November 2002 Issue --- http://www.business2.com/articles/mag/0,1640,44304,FF.html 

Early in September, Microsoft (MSFT) had a small confession to make. Back in December 2000, the company had lent its president, Rick Belluzzo, $15 million, taking some of his stock options as collateral. Though the options were underwater and had no value at the time, Microsoft figured its stock would eventually go up. But by last August, when Belluzzo resigned, the options were even further submerged. So the software giant forgave the loan -- it had no choice under the deal Belluzzo had struck -- charged off the $15 million, and said its belated disclosure was "appropriate" because the loan was really just an "advance."

Corporate scandals are so big and bountiful these days -- Tyco (TYC) and WorldCom (WCOM) were getting the headlines the week Microsoft made its disclosure -- that the significance of the little item was easy to miss. Next to alleged accounting fraud and corporate looting, the practice of making and pardoning insider loans, even multimillion-dollar ones, seems like small beer. And why single out Belluzzo? He hadn't left his company in tatters like Lucent's (LU) Richard McGinn, Mattel's (MAT) Jill Barad, Webvan's George Shaheen, and the few other executives who made news by having their multimillion-dollar company debts erased as they headed out the door. Compared with WorldCom's (WCOM) Bernie Ebbers, whose officially disclosed unpaid loans stand at $160.8 million, Belluzzo hardly seems to rate.

Yet Belluzzo symbolizes an aspect of the ongoing revelations about boom-time corporate excess that, until now, has escaped notice: Insider lending and the subsequent forgiving of those loans didn't just benefit a few alleged corporate rogues and failed executives. It was astoundingly common. Read the full story >>http://www.business2.com/articles/mag/0,1640,44304|2,FF.html

AICPA Issues New Audit Standard for Detecting Fraud --- http://www.smartpros.com/x35638.xml 

Bob Jensen's threads on other proposed reforms are http://www.trinity.edu/rjensen/FraudProposedReforms.htm 

Winning Essay: "Accounting: a Pillar of the Free Market" --- http://www.smartpros.com/x35605.xml 

Oct. 14, 2002 (Pennsylvania CPA Journal) — In an effort to encourage accounting students to improve their writing abilities, the Pennsylvania CPA Journal Editorial Board sponsors an annual Student Writing Competition. This year, for the first time, the contest was open to all business majors attending Pennsylvania colleges and universities, as well as to Pennsylvania residents who attend school out-of-state.

--------------------------------------------------------------------------------

The 2002 topic was Accounting's Role in the Creative Destruction Process. Harris Arch, a student at the Wharton School of the University of Pennsylvania, placed first and received a cash award of $2,000. The Wharton School also received $1,000 for his achievement. Andell Lewis of Ursinus College placed second and received $1,200. Justin Stolte, also of Ursinus College, placed third and received $800. Ursinus College was awarded $1,000 ($600 and $400, respectively) for its students' achievements.

Special thanks go to contest chair and judge Frank Farina and to judges Steve Blum and Rose Marie Bukics--all members of the Pennsylvania CPA Journal Editorial Board-for their hard work and dedication to this program.

Winning Essay: The following is an excerpt from the Student Writing Competition's first-place essay, written by Harris Arch from the Wharton School of the University of Pennsylvania. To read the complete paper, please visit CPAzone.org, click on Contest & Awards, then go to Student Writing Competition.

Accounting: A Pillar of the Free Market By Harris Arch, The Wharton School of the University of Pennsylvania

Joseph Schumpeter's "creative destruction" theory is critical to the understanding of the role of accounting within the free market. In his famous text, Capitalism, Socialism, and Democracy, Schumpeter wrote, "The fundamental impulse that sets and keeps the capitalist engine in motion comes from the new consumers, goods, the new methods of production or transportation, the new markets, the new forms of industrial organization that capitalist enterprise creates."

Schumpeter's observations demonstrate keen insight because the history of the American free market has consistently supported the force of change. Businesses must be able to adapt to markets that are dynamic and be responsive to consumers' changing habits or new methods of production. ... Schumpeter argued that innovation would always remain in the free market economy, and consequently the old structure and processes would be "destroyed" by new, more efficient ways of business. Schumpeter's theory is a powerful force in the free market economy and a reminder that innovation will never become obsolete as the economy develops...

One of the questions of interest in this paper is how the role of accounting affected the dot-com boom of the late 1990s. To support the growth of the technological businesses, these companies needed an infusion of capital. These investments could have come from venture capital, initial public offerings in the stock market, loans, or various other financing vehicles. Regardless of the financing choice, investors needed a way to accurately value the operations of the company and determine the growth potential. The role of accounting is to provide these investors with reliable information about a company's earnings and balance sheet accounts.

The accounting profession's responsibility should not be taken lightly, because investing decisions hinge upon the provided numbers. When an investor reads that earnings grew 25 percent from the previous quarter or revenues decreased 10 percent year-to-date, the investor needs to have the ability to assume that information is correct to the best of the knowledge of the accountant. Without this crucial assumption, investors would inefficiently allocate capital in companies that are not optimal and the innovation of the free market that Schumpeter described would become undermined. ...

For Schumpeter's "creative destruction" to occur, true technological innovators need investment to support their fledgling companies. Recently, there have been serious issues about companies overstating their earnings, such as Sunbeam, Waste Management, and Enron. Investors need to have confidence that earnings reports are correct. If the worries over accounting continue, the free market and the ability to raise funds will become seriously constrained. When earnings are reported, investors will not be certain that these numbers are correct and may be hesitant to invest. Without capital, our free market will not be able to develop sufficiently and fund enterprises that provide value to the economy. ...

The beauty of the free market is its own self-sustaining capabilities. The market can function by itself without strong intervention from the government, but some regulation is needed to support the self-sustainability. Accounting is one such pillar of strength for the free market. For investors to be able to develop proper investing decisions, the accounting numbers must be accurate. If not, our economy will suffer from poor capital allocation decisions based upon faulty numbers. Schumpeter's idea of "creative destruction" in the economy is a testament to the strong innovative character of our society. That innovation cannot occur without support from the accounting profession and standards. Without innovation, our economy will overlook potential growth opportunities, and the dreams of a better standard of living in the future may not see fruition.

And then there is the dark side --- http://www.trinity.edu/rjensen/fraud.htm 

Politics as Usual on the Beltway

October 21, 2002 message from Craigpolhemus@aol.com 

Unfortunately, partisan Democrats went even further in both politicizing and personalizing the process by attacking SEC Chairman Pitt a month before the election. And now Congress recesses without appropriating funds for the SEC and the President calls for a reduction in the SEC enforcement funds included in Sarbanes-Oxley and in the Senate Appropriations Committee bill! Politicians of both parties are politicizing the SEC as never before.

As I noted in my very first PCAOB article submitted to the Washington Times ("Mary Poppins vs. the Chamber of Commerce"), which you posted at http://www.trinity.edu/rjensen/000aaa/polhemus/commentary01.htm , the lack of PCAOB independence from government may well prove a fatal flaw:

Craig

You can read more about Craig at http://www.geocities.com/craigpolhemus/index.html 

"It's Time For Him to Go:  The Securities and Exchange Commission is desperate for strong leadership--and Harvey Pitt isn't providing it," by Jeffrey H. Birnbaum, FORTUNE, October 28, 2002, pp. 99-102 --- http://www.fortune.com/indexw.jhtml?channel=artcol.jhtml&doc_id=209836 

For a while there, it was starting to look as if Harvey Pitt finally got it. After nearly a year of being a day late and a dollar short as corporate scandals mounted and investor confidence eroded, the Securities and Exchange Commission chairman seemed to be getting tough on the bad guys. He dispatched teams of SEC staffers to ferret out major-company frauds. He stopped trading verbal jabs with New York attorney general Eliot Spitzer--who has been far ahead of the SEC in exposing Wall Street