Accounting Scandal Updates on November 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 

Exodus of Enron employees carrying all their worldly possessions.
Bob Jensen's Enron humor threads --- http://www.trinity.edu/rjensen/fraud.htm#Humor 

Outstanding animations of imploding buildings! 
ImplosionWorld --- http://www.implosionworld.com/  
Sort of reminds me of the public image of corporate CEOs, CFOs, CAOs, and their auditors.

But in contemporary United States, something happened to the national memory. In the last ten years, top executives of a stunning number of very large corporations committed fraud and theft, doctored their books, created false entities designed to let insiders rake in billions when many of them knew their corporations were in crisis. For numerous firms the crisis was fatal and hundreds of thousands of their workers lost their jobs and were cheated of their old-age pensions. It was not only the Enrons and WorldComs but some of the most prestigious monuments of American capitalism — some of the country's oldest and largest banks and accounting firms.
Ben Bagdikian --- http://www.zmag.org/sustainers/content/2002-10/28bagdikian.cfm  

Mr. Berardino (former Andersen CEO) recommends a change in audit opinions from a clean opinion vs. a qualified opinion to opinions issued on a graded scale. He also encourages a change from rules-based accounting to a principles-based model. And he added, "We must increase our ability to detect fraud."
AccountingWeb --- http://www.accountingweb.com/cgi-bin/item.cgi?id=96386 

Those days have certainly changed. I have not seen a poll on this subject, but I would bet that a very high percentage of Americans today know about the Securities and Exchange Commission. I was stunned recently when an airport security man in Atlanta saw "SEC" on my laptop and asked me if I worked at the Securities and Exchange Commission or with the South Eastern Conference. A year or so ago, I'm certain he would have assumed I worked for the football conference. In truth, I'll bet that he was hoping that I could have revealed some inside information about the Georgia Bulldogs' next game instead of inside information about recent rule promulgations under the Sarbanes-Oxley Act. But, alas, his knowledge about my employer did reaffirm my belief that these are unique times and that the SEC has gone mainstream. Whether or not this is a good thing is a debate for another time.
SEC Commissioner Paul Atkins (forwarded by Dennis Beresford from the University of Georgia)

Here's another story for the list. A professor of mine told us about how he was on an audit in the Houston area, though he was from the Dallas office. He observed an inventory count in one warehouse and headed back to his hotel. Part way there, he realized -- horrors! -- that he'd left his briefcase with the workpapers at the warehouse. He had the taxi take him back to the warehouse, where he found 18-wheelers at every dock, loading the inventory to take to the other warehouse for the next day's count! Sometimes being careless with your briefcase can bring unexpected benefits, eh?
Linda Kidwell Niagara University

"The Man With Nine Lives, by Elizabeth MacDonald, Forbes, November 25, 2002 --- http://www.forbes.com/forbes/2002/1125/060a.html 
Under fire from accounting scandals and charges of self-dealing, Barry Melancon is hanging on as head of the American Institute of Certified Public Accountants

For Barry Melancon, the 44-year-old chief executive of the accounting industry's self-regulatory body, it's been a terrible year. A wave of accounting scandals has damaged the AICPA's image. On his watch, the AICPA has been accused of giving short shrift to the auditing rules it sets, which are supposed to protect investors. And under Melancon, the AICPA has set up a Web site that ignited a barrage of conflicts-of-interest charges against him.

Some 160 member accountants have signed a petition asking him to resign. BDO Seidman, the fifth-largest accounting firm, has sued the AICPA over the site, alleging Melancon is trying to enrich himself and that the AICPAis wrongfully competing with accounting firms. An AICPA member has filed an ethics violation accusing him of self-dealing. (None of the AICPA's chiefs, including Melancon, has ever had a finding against them.) Now, Congress has yanked the AICPA's auditing oversight duties away from it and given them to a new federal board. Some wonder how Melancon can hold on to his job.

"I think the AICPA under Melancon's leadership has been the least effective, most backward, most obstructionist group that I encountered in my eight years running the SEC," says Arthur Levitt, former Securities & Exchange Commission chairman. Lynn Turner, former SEC chief accountant, agrees. "If Melancon were a CEOof a company, he'd be fired by now," says Turner, who recently received a big round of applause in a speech before 700 accountants when he called for Melancon to step down.

Part of Melancon's problem is that he's a lightning rod at the worst time for accountants. "Unfortunately, the actions of a few bad ones reflect negatively on all of us," he says. But during his term, the things the AICPA let slide when the markets were at giddy heights are believed to have hurt investors. For instance, Melancon fought the SECover auditor independence rules that Levitt and Turner say would have stopped conflicts involving auditors selling consulting services to their audit clients. The AICPA also didn't tighten rules for simple things, like forcing auditors to provide detailed documentation for an audit or to query lower-level management for problems or even to look at journal entries, says Douglas Carmichael, director of the Center for Financial Integrity at Baruch College in New York. Instead the rules get lazy auditors off the hook by simply letting them obtain a letter from a company that says it isn't faking its numbers, says Carmichael, who notes auditors like weak rules, since they can use them as a defense when sued.

So why doesn't the AICPA boot Melancon? Because he's a business builder intent on making a buck--and that's what its board wants him to do. "Barry brought to the AICPA what the profession wanted: a business approach," says board member Michael Mountjoy. Melancon adds the AICPA has "not reduced one iota the resources" that it puts into standards.

To turn a profit, Melancon launched the site, called CPA2Biz, in February 2001. As chairman of the Web site, he got CPA2Biz the exclusive rights to sell the nonprofit AICPA's products, such as auditing manuals. The products brought in $64 million out of the institute's $165 million in 2001 operating revenue. The AICPA raised $70 million from investors such as Microsoft, Thomson and Aon, which bought half the site; the institute invested just $900 for its 50% stake. While the site has never made a profit, Melancon says the companies are at risk for losses. "In other environments people would be lauded for that," he says.

An initial public offering (at a possible $10 a share) was planned for the site. That meant Melancon's personal $100,000 investment in the site could have been worth $12 million. Though no IPOhas occurred, accountants fumed over his stake, which he says won board approval. To quell his critics, Melancon announced in March that he donated it to an accounting foundation.

Even so, Melancon has morphed the once-venerable AICPA into a paid endorser of its financial backers' products, some of which were denounced as inferior by accountants, like Microsoft's small business accounting software, which was eventually killed. And the AICPA gave a contract worth millions to a Thomson unit for exclusively administering an electronic version of the CPA exam. Though that raised the ire of the Texas State Board of Public Accountancy, it now says Melancon has since convinced it that the unit was the best outfit for the job.

While the board says it is behind its man, Melancon hedges whether he will renew his five-year contract when his second term expires in 2005. "We went through a hard year," he says.

From Watson Wyatt Worldwide --- http://www.watsonwyatt.com/research/resrender.asp?id=W-584&page=1# 
Corporate Governance in Crisis: Executive Pay/Stock Option Overhang 2003

Corporate America is in crisis. Scandals, bankruptcies, questionable accounting and the like are eroding public trust. Poorly timed or possibly even fraudulent stock sales by key company executives are igniting legislative action. The overall economy is struggling, the stock market is in a heightened state of volatility, and investor confidence has plummeted so low that CEOs are now legally required to sign a pledge of honesty.

As a result, all the goodwill created by corporate America with the gains of the 1990s has vanished. Executive pay is once again under heavy public scrutiny, and calls to link pay with accurate measures of performance are louder than ever before.

Executive pay, especially CEO pay, has become a lightning rod for this collapse in investor confidence for a number of reasons. CEO pay levels in a few instances have reached into the hundreds of millions of dollars for a single year, raising the question of whether any employee is worth that type of money — especially in cases of a company’s mediocre or even poor performance. There also have been recent examples of overstated profits or outright fraud. Such situations are compounded by the ability of executives to time the exercise of their options and the sale of their stock, and by the fact that stock options are accounted for differently from other forms of compensation.

We believe that the executive pay situation offers a key window into the corporate governance crisis facing America and, accordingly, provides a possible solution. The companies with the pay governance processes that are most transparent and most aligned will be the ones to inspire the most investor confidence.

Watson Wyatt research clearly and consistently documents that a company’s executive pay levels are directly and positively correlated with its financial performance. Companies that give their executives a greater stock incentive opportunity outperform companies with lower opportunity. We also have found that companies with high levels of stock ownership at the executive and other employee levels substantially outperform their low stock ownership counterparts. In fact, our research has shown that stock ownership is more effective than stock options in this regard.

The research in our 2003 Executive Pay/Stock Option Overhang study bears this out. In particular, our findings show:

• Companies with senior executives with high stock ownership financially outperform companies with lower executive ownership. This performance is measured by Total Returns to Shareholders (TRS), Return on Equity, Earnings Per Share (EPS) growth and Tobin’s Q, among others.
  
• Companies with high actual CEO pay have better historical financial performance, as measured by TRS, than companies with low actual pay.
  
• Both cash compensation and stock option profits are highly sensitive to shareholder returns.
  
• Stock options remain a positive factor in company and economic performance despite the current economic uncertainty and the fact that fewer options are now being exercised. However, our research also shows that companies with excessively large amounts of stock option “overhang” have lower returns to shareholders than companies with more moderate usage. In addition, the optimal point in stock option overhang has gone down dramatically for companies in the high-tech sector.

To better understand some of the concerns of investors, we have investigated the impact of executive pay and stock option overhang on financial performance. The world of executive pay could change in unpredictable ways over the next few years. We believe that our statistical research on pay, ownership and options could be helpful in setting the future direction.

This report details those findings. The first section focuses on executive pay; the second on stock option overhang. It is interesting to note that, if the rules for accounting of stock options change significantly (as we now think likely), it is possible that stock option overhang will become a less important measure. For now, however, these historically reliable gauges continue to offer valuable insights.

Continued at  http://www.watsonwyatt.com/research/resrender.asp?id=W-584&page=1#  

FEI Video on Corporate Governance --- http://www.fei.org/video/

What Does the Future Hold for CPA Firm Consulting? --- http://www.smartpros.com/x35960.xml 

From SmartPros --- http://www.smartpros.com/x35970.xml 
Why do good accountants do such bad audits?

Nov. 14, 2002 (Cox News Service) — Few events have shocked investors as much as the accounting frauds disclosed by major U.S. corporations this year. Even accountants can be crooked, many people concluded. Unfortunately, it's not that simple, Harvard Business Review (November) says in a special report, "Why good accountants do bad audits."

---

For one thing, HBR says the highly touted Sarbanes-Oxley Act passed by Congress this year to reform the accounting profession is not likely to succeed because it attacks the wrong problem.

That conclusion is based on research by Max Bazerman of the Harvard Business School and George Loewenstein and Don Moore of Carnegie Mellon University. They conclude that the problem with fraudulent auditing is not corruption but the "unconscious bias" of accountants who are too close to their clients.

"Because of the often subjective nature of accounting and the close relationships between accounting firms and their corporate clients, even the most honest and meticulous of auditors can unintentionally massage the numbers in ways that mask a company's true status, thereby misleading investors, regulators and even management," the authors say.

The solution they recommend is for accounting firms to be auditors or business consultants, but not both, and for companies to routinely rotate outside auditors. As for accountants, they need to be more aware of "the profound impact of self-serving biases on their judgement," HBR says.

If accountants are under fire, corporate chief executives are being atom-bombed as a result of corporate fraud disclosures, says Fortune (Nov. 18) in a specual issue devoted to "the CEO under fire."

Today's disgraced chieftains are the products of 100 years of evolution, resulting in the CEO as tyrant, statesman and destroyer. One problem is Wall Street's deification of CEO stars, which often "sets investors up for a fall." The good news, says Fortune, is that "the latest crop of CEOs is disciplined, deferential, even a bit dull -- what a relief!"

Survey: Damaged Perception of Accounting Profession Not Likely to Change --- http://www.smartpros.com/x36059.xml 
By: SmartPros Editorial Staff

HOUSTON, Nov. 21, 2002 — Accounting professionals believe the past year's scandals have significantly damaged the profession's reputation, and that new legislation won't fix the problem, according to a recent survey.

More than 170 accounting professionals weighed in on the recent changes in accounting standards at the Chamberlain Hrdlicka 25th Annual Tax & Business Planning Seminar earlier this month.

Even the aggressive Sarbanes-Oxley Act will not help to salvage the diminished public perception of the profession, respondents said. In narrow results, just over half of respondents believe that the Act and other SEC changes will help to achieve the goal of encouraging public companies to produce more accurate financial statements. And when asked if malpractice or other concerns would cause accounting firms to adopt the Sarbanes-Oxley standards, even if the firm would not otherwise be covered, 63 percent of those surveyed said no.

"From this survey, it is clear that there are mixed opinions about the state of the accounting industry," said George Hrdlicka, co-founder and shareholder of Chamberlain Hrdlicka.

In the last fiscal year, over 150 criminal cases relating to retirement fund fraud were opened, resulting in the indictment of over 135 individuals. To help protect the 46 million Americans who are building their own retirement nest egg, the Pension and Welfare Benefits Administration offers the following warning signs that pension contributions are being misused. http://www.accountingweb.com/item/96774 

Warning Signs That Pension Contributions Are Being Misused

1. Your 401(k) or individual account statement is consistently late or comes at irregular intervals
   
2. Your account balance does not appear to be accurate
   
3. Your employer failed to transmit your contribution to the plan on a timely basis
   
4. A significant drop in account balance that cannot be explained by normal market ups and downs
   
5. 401(k) or individual account statement shows your contribution from your paycheck was not made
   
6. Investments listed on your statement are not what you authorized
   
7. Former employees are having trouble getting their benefits paid on time or in the correct amounts
   
8. Unusual transactions, such as a loan to the employer, a corporate officer, or one of the plan trustees
   
9. Frequent and unexplained changes in investment managers or consultants
   
10. Your employer has recently experienced severe financial difficulty

Volcker Calls for Non-Exec Board Structure in Large Corporations
Former Federal Reserve Board Chairman Paul Volcker, once the top contender to head the Public Company Accounting Oversight Board before withdrawing his name from consideration, called on large public corporations to establish a board structure that allows non-executive board members to exert authority over the chief executive officer --- http://www.smartpros.com/x35862.xml 

Three Accounting Firms Sued for Raiding Andersen's Assets --- http://www.accountingweb.com/cgi-bin/item.cgi?id=96380 

AccountingWEB US - Nov-13-2002 - Three accounting firms are being sued for looting Andersen's assets and leaving it unable to pay retirement benefits. A class action suit seeks damages of $500 million to $1 billion to cover lost retirement payments for roughly 1,000 former partners of Arthur Andersen. The defendants named in the suit include Deloitte & Touche, Ernst & Young, and KPMG as well as BearingPoint, formerly KPMG Consulting. They are accused of interfering with contractual relations, acquiring Andersen's assets at below fair value and conspiring to suppress that value.

Among other things, the suit cites two "war rooms" operated in Chicago by 100 Deloitte employees. One room targeted Andersen's people for possible jobs, while the other targeted Andersen's clients

Continued at http://www.accountingweb.com/cgi-bin/item.cgi?id=96380 

A portion of a November 22, 2002 message from Risk Waters Group [RiskWaters@lb.bcentral.com] 

... the US energy trading markets suffered a series of setbacks this week with allegations that Houston-based El Paso swapped power contracts with Morgan Stanley to avoid a restatement of earnings. El Paso is said to have swapped power contracts for the five-year period 2006-2011 for the period 2011-2016 in an attempt to convince its auditor, PricewaterhouseCoopers (PwC), that there was still a viable market for power 10 years into the future. In doing so, it convinced PwC that profits it had booked from a previous long-term deal – extending 15 years – were likely to be realised.

Additionally, UBS said it will close its Houston-based energy trading desk, laying off an undetermined number of staff, and Fitch warned that US power and gas companies face another grim year in 2003 as liquidity risk, market weakness and litigation and regulatory concerns seem set to continue. On the exchange front, US single-stock futures trading company OneChicago expanded its product suite with 22 more stock listings. It will also introduce futures on ‘Diamonds’ – shares in an exchange-traded fund that is designed to track the performance of the Dow Jones Industrial Average. The new single-stock futures contracts are in addition to the 21 listings posted at the launch of the market on November 8. A spokeswoman for the company – a joint venture between the Chicago Board of Trade, the Chicago Mercantile Exchange and the Chicago Board Options Exchange – said an average of 3,500 contracts per day were traded on OneChicago’s platform in the first six days of business.

United Way Accounting is Questioned

Double booking of revenues, counting revenues targeted to other organizations, and booking volunteer's time as contribution revenues are all accounting practices that are now being questioned at the United Way, according to a report by the New York Times. http://www.accountingweb.com/item/96768 

AccountingWEB US - Nov-20-2002 -  Double booking of revenues, counting revenues targeted to other organizations, and booking volunteer’s time as contribution revenues are all accounting practices that are now being questioned at the United Way, according to a report by the New York Times.

Brian A. Gallagher, president of the United Way of America, indicated that while some of the practices in question conform to GAAP, the post-Enron scrutiny of accounting practices require that the organization now respond to the issues in question.

Many of the practices result in inflated revenues for the local member organizations. The concern is that donors are entitled to know what percent of their contributions are going to the charity and what percent are going to administrative costs, and the inflated revenues tend to show a smaller percentage going to administrative overhead.

Among the issues being questioned:

• Double Counting: Occurs when two or more United Way affiliates claim the same contribution as their own.
  
• Third Party Campaigns: The full amount raised by in-house corporate campaigns which raise money from employees for multiple charities are sometimes 100% recognized as United Way revenues, even when less than 100% of these funds are earmarked for the United Way.
  
• Valuation of Donated Goods: Concerns are being raised on how United Way members value donated goods and services which are then counted towards contribution totals.
  
• Counting Volunteer Time: United Way encourages its members to report their volunteer time at $14.83 per hour and count those hours towards the total contributions. FASB allows this practice only for certain volunteer activities, but often all of the volunteer time is counted.
  
• Unrestricted Gift Allocations: Restricted gifts have limits as to where the money is to be allocated – including administrative overhead – but unrestricted gifts often are tapped for a larger overhead contribution, thereby skewing the administrative costs percentages.

Member organizations of the United Way are independent organizations, not subject to uniform reporting guidelines, practices, or even accounting software. Member organizations assert that this independence allows them to better react to their local community’s needs without worrying about “big brother” oversight. The tug-of-war between the independence of the organizations and the centralized control of the national United Way organization will continue to be debated.

Bob Jensen’s threads on controversial revenue accounting can be found at http://www.trinity.edu/rjensen/ecommerce/eitf01.htm

Seven professional associations have jointly issued recommendations to help companies combat fraud. The guidelines tell how to prevent, deter and detect frauds ranging from falsified financials to employee theft. http://www.accountingweb.com/item/96765 

Recommended anti-fraud measures include creating a culture of honesty and high ethics, being proactive in implementing and monitoring effective internal controls, and developing an effective oversight function.

A document containing the recommendations, "Management Anti-Fraud Programs and Controls," is available at AICPA's Web site. This document will be included for information purposes as an exhibit in the printed version of Statement on Auditing Standards No. 99, Consideration of Fraud in a Financial Statement Audit. The electronic version of SAS 99 is also being conformed to include the exhibit.

The organizations sponsoring the document are the American Institute of Certified Public Accountants, Association of Certified Fraud Examiners, Financial Executives International, Information Systems Audit and Control Association, Institute of Internal Auditors, Institute of Management Accountants, and the Society for Human Resource Management.

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

The Financial Accounting Standards Board has issued another invitation to comment on stock-based compensation. This one asks for your views on accounting for the fair value of employee stock options. http://www.accountingweb.com/item/96757 

The FASB's news release and links are at http://www.fasb.org/news/nr111802.shtml 

"New Charges Made in Suit on Homestore," by David D. Kirkpatrick, The New York Times, November 16

A complaint filed yesterday in a suit by a large shareholder against the online real estate company Homestore.com makes new accusations of financial fraud at AOL Time Warner, including detailed descriptions of conversations between senior executives who, it says, were planning to inflate revenue improperly at both companies.

 

Federal prosecutors and securities regulators are already investigating possible financial improprieties at both Homestore and AOL Time Warner. The complaint sheds new light on the progress of the investigations because it draws on some of the information that federal prosecutors have gathered.

 

The complaint, filed by the California State Teachers' Retirement System in District Court in Los Angeles, cites information from anonymous executives said to be involved in Homestore's questionable deals.

But people involved in the federal inquiries said that much of the information came from lawyers for three former Homestore executives who pleaded guilty and provided the same information to investigators.

 

The complaint, which adds AOL Time Warner and several other companies as defendants in a previously filed suit against Homestore, portrays two former AOL Time Warner executives — David M. Colburn, head of the AOL division's business affairs department, and Eric Keller, a deputy in the department — as conspiring with their counterparts at Homestore to devise and conceal transactions that overstated the revenue of both companies.

 

AOL Time Warner has dismissed both executives, although it has not provided details about the reasons. Everett C. Johnson Jr., a lawyer for Mr. Keller, and Roger Spaeder, a lawyer for Mr. Colburn, could not be reached. A spokesman for AOL Time Warner declined to comment.

 

In recent weeks, AOL Time Warner has conducted an internal investigation into the accounting at the AOL division, which last month reduced its previously reported revenue for the eight quarters that ended last spring by about $190 million, a tiny portion of its sales. Homestore has acknowledged much more extensive accounting problems in 2000 and 2001.

 

The complaint contends that executives of Homestore and AOL Time Warner invented schemes to inflate revenue of both companies without detection by creating three-way transactions that used bogus advertising buyers as intermediaries. According to the complaint, those transactions took place in the spring of 2001 when AOL Time Warner was in talks about acquiring Homestore.

 

After AOL Time Warner suspended Mr. Keller for his role in similar questionable deals, the complaint contends, other senior executives of AOL Time Warner continued to permit some of the three-way deals to continue for another quarter, even after initially raising concerns.

 

Securities regulators are investigating the dealings of Cendant, the real estate and travel company, with Homestore.com. --- 
http://www.nytimes.com/2002/11/25/business/25CEND.html?ex=1039223264&ei=1&en=b55a66c398cc57fd 

From the AccountingWeb on November 14, 2002 --- http://www.accountingweb.com/cgi-bin/item.cgi?id=96530 
Hit List Picked For Fast-Track FASB/IASB Convergence

Under the tentative game plan for next six months, FASB will examine the topics one at a time and either make the decision to switch to the standard chosen by the International Accounting Standards Board (IASB) or throw the topic back into the hopper for later consideration.

The pivotal question on the decision tree will be: "Is IASB's method better than, or at least as good as, the U.S. standard?" If the answer is "Yes," FASB plans to propose a change to IASB's method. If the answer is "No" or "Needs more study,"” the topic will go back into the hopper until its number comes up again at a later time.

The 17 topics are as follows:

1. Classification of liabilities upon a refinancing
   
2. Classification of liabilities payable on demand due to breach of borrowing agreement
   
3. Voluntary changes in accounting principles
   
4. Distinction between changes in accounting principles and changes in accounting estimates
   
5. Inventories – idle capacity and spoilage costs
   
6. Nonmonetary asset exchanges
   
7. Financial instruments: disclosure, presentation, recognition and measurement
   
8. Interim reporting
   
9. Research and development
   
10. Discontinued operations
    
11. Costs associated with exit or disposal activities
    
12. Government grants
    
13. Depreciation on assets held for disposal or idle assets
    
14. Income taxes
    
15. Long-term construction contracts
    
16. Financial reporting in hyperinflationary economies
    
17. Joint ventures and the proportionate consolidation method

This is one of those projects where the trees are easier to see than the forest. The specific issues up for reconsideration within each of the above topics are apparently already quite well defined. In contrast, the objectives of the project still seem to have some rough edges.

Coantinued at http://www.accountingweb.com/cgi-bin/item.cgi?id=96530  

SmartPros List of Selected Accounting Textbooks --- http://www.smartpros.com/x34694.xml 
This includes accounting for specialists versus non-specialists.