Accounting Scandal Updates and Other Fraud on December 31, 2003
Bob Jensen at Trinity University

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

There are some financial executives who do/did the right thing (e.g., blow the whistle) when confronted with an ethics issue.  There are some nice examples of real executives in real situations in the following article:
"Financial Execs Who do the Right Thing," by Jeffrey Marshall adn Ellen M. Heffes, Financial Executive, November 2003, pp. 32-38 --- http://www.fei.org/mag/articles/11-2003_cover.cfm 

Quotations

S. Scott Voynich, Chair of the American Institute of Certified Public Accountants, has stated that further changes were necessary to regain the confidence of American investors. Voynich was the keynote speaker at the Institute’s 2003 AICPA National Conference on Current SEC Developments  .
http://accountingeducation.com/news/news4675.html 

Nothing wrong with overcharging, so long as everyone else is doing it, right?
Gretchen Morgenson"The Mutual Fund Scandal's Next Chapter," The New York Times, December 7, 2003
(See below)

Are you disgusted enough with mutual funds to raise a stink?  So far, savers don't seem nearly as outraged as they were about Enron--yet deceptive funds and sneaky "financial advisers" have swiped more money, from more people, than all the corporate scandals combined.  The House of Representatives just passed a reform bill, but in the Senate, the going looks tough.  Your legislators are scooping up money from the mutual-fund lobby, which hopes to head off any major change.  To counter the lobby, Congress needs angry protest calls from voters like you.
Jane Bryant Quinn (See Below)

One the one hand, eliminating the middleman would result in lower costs, increased sales, and greater consumer satisfaction;  on the other hand, we're the middleman.
New Yorker Cartoon, Page 29, The New Yorker Book of Business Cartoons
In the context of the recent mutual fund scandals, financial advisors have become those middlemen.

Boyer had also asked Kmart's auditors at PricewaterhouseCoopers in several cases to look into various accounting issues and was unsatisfied with the firm's work, according to the lawsuit.
"Fired From Kmart, Ex-CFO Is Key Figure in Lawsuits," SmartPros (See below)

"I believe this (mutual fund rip-off) is the worst scandal we've seen in 50 years, and I can't say I saw it coming," said Arthur Levitt, the former chairman of the Securities and Exchange Commission for nearly eight years under the Clinton administration. "I probably worried about funds less than insider trading, accounting issues and fair disclosure to investors" by public companies.
Stephen Labaton --- http://www.trinity.edu/rjensen/fraud.htm#Cleland 

Illegal or unfair trading isn't hard for directors (or the SEC) to spot, says New York Attorney General Eliot Spitzer, who brought the first of these scandals to light.  They just have to compare their funds' total sales with total redemptions.  When the two are about the same, skimming might be going on.  I asked Lipper, a fund-tracking service, to list the larger funds where redemptions reached 90 to 110 percent of sales.  It found 229, some looking obviously churned.
Jane Bryant Quinn --- http://www.trinity.edu/rjensen/fraud.htm#Cleland 

One thing your can count on:  When you invest, a lot of the people you trust are going to cheat.  Billions of investor dollars whirl through the system.  It's all too easy for insiders to stick their hands into that current and grab.  We're not talking about a bad apple here and there.  Cheating runs through Wall Street's very seams --- even in the sainted mutual funds.
Jane Bryant Quinn --- http://www.trinity.edu/rjensen/fraud.htm#Cleland 

But Wall Street's Lobbyists Still Have a Firm Grip Where it Counts
While Representative Baker pushes his bill in the House, the Senate is not expected to take up a measure before next year. Some lawmakers have filed bills, but Senator Richard Shelby, the Alabama Republican who heads the Senate banking committee, has said he is not convinced of the need for new laws.
Stephen Labaton, "S.E.C. Offers Plan for Tightening Grip on Mutual Funds," The New York Times, November 19, 2003 --- http://www.nytimes.com/2003/11/19/business/19sec.html 

You can read more about SEC Chairman William H. Donaldson's defense of his quick and some say marshmallow punishment of mutual fund cheaters at http://www.trinity.edu/rjensen/fraud.htm#Cleland  

What makes this such a big scandal is that the savings of half the households in the U.S. are at stake here.  The tragedy is that now that the scandal is surfacing in the media and in state courts, the SEC is only wrist slapping mutual funds.  This is along with the continued wrist slapping of investment banking (e.g., why is Merrill Lynch still in existence after frauds dating back to Orange County ?) is the real evidence of industry power over regulators.  Sarbanes-Oxley won’t do it!  It’s still rotten to the core in Washington DC as long as industries have regulators in their well-financed  pockets --- http://www.trinity.edu/rjensen/fraud.htm#Cleland 

Fraud: What Starts Small Can Snowball
Paul Sweeney --- http://www.smartpros.com/x41723.xml 

At a time when HealthSouth Corp.'s finances were spiraling into scandal, the company was paying its audit firm more to check for clean toilets than it was for clean books. The allegation was brought to light last week as part of a House hearing looking into HealthSouth's $2.7 billion accounting scandal.  
AccountingWeb, "HealthSouth Officials All Flush About 'Pristine Audit' Costs,"
November 13, 2003 --- http://www.accountingweb.com/item/98316 

At a time when HealthSouth Corp.’s finances were spiraling into scandal, the company was paying its audit firm Ernst & Young LLP more to check for clean toilets than it was for clean books.

The allegation was brought to light Thursday as part of a House hearing looking into HealthSouth’s $2.7 billion accounting scandal.

"By hundreds of thousands of dollars, Ernst & Young was charging more to check the magazine racks and the toilets than they were to do the audit," Rep. Cliff Stearns, R-FL, said during the House Energy and Commerce subcommittee hearing.

Former CEO and founder Richard M. Scrushy devised a program called "Pristine Audits" whereby Ernst & Young auditors were hired during 2000 and 2001 to perform inspections of the cleanliness and physical appearance of HealthSouth's approximately 1,800 surgical and rehabilitation facilities.

Scrushy was indicted earlier this week on 85 federal criminal charges, including conspiracy, securities fraud, wire fraud, mail fraud, making false statements, providing false certifications and money laundering.

The auditors were given a 50-point checklist as a guide in their examination of such features as stains on toilets and ceilings, liners in trash receptacles, and the orderliness of magazines in waiting rooms.

Ernst & Young was paid more for the Pristine Audits than for financial audits, but all of the services were categorized as audit-related fees on HealthSouth's financials. Since 2000, the SEC has required publicly held firms to identify how much is paid to audit firms for non-audit-related services.

At Thursday’s hearing, Stearns said that Ernst & Young was paid more than $2.6 million to do the pristine audits and $2.1 million in 2000 and 2001 to conduct financial audits.

Stearn confronted the company’s acting chief executive officer, chairman of the board and two current board members to find out what they knew about Ernst & Young being paid more to inspect facilities than to audit the books, the Wall Street Journal reported.

"I did not know about the total charges," said Joel Gordon, HealthSouth's acting chairman.

Note from Bob Jensen
Some people wrote and asked me why Ernst & Young would be auditing toilet cleanliness in the first place. This is part of the new assurance service offered by CPA firms called Elder Care Assurance Service --- http://www.aicpa.org/pubs/tpcpa/jan98/elder.htm 
(Roger Debreceny later questioned my conjecture as to whether this was Elder Care Assurance or a consulting engagement, and we are still awaiting a definitive answer from E&Y.)

Elder care assurance is one of the most successful new lines of CPA services proposed by Bob Elliott’s Committee on Assurance Services for the AICPA. It has been generating large revenues for some CPA offices as evidenced by the fact that HealthSouth paid much more for Elder Care Assurance Services from E&Y than HealthSouth paid for its E&Y financial audit.

I also tell them that the new accounting fashion trend is a green eyeshade with matching white gloves!

In an effort to cut cost, WorldCom no longer audits toilets.
WorldCom, which won a federal judge's approval for its reorganization plan earlier this month, has piled up fees at a rate of $10 million a month. 
AccountingWeb, November 13, 2003 --- http://www.accountingweb.com/item/98341 

In a new national study of nearly 200 chief executive officers, 81% expressed concern over threats to their corporate reputations, citing customer service problems, financial irregularity, negative press coverage and employee misconduct as among the issues that have the greatest potential to damage their corporate reputation. http://www.accountingweb.com/item/98328 

The Lawyers and Accountants Hit'em Hardest When Their Down
Executives from failed energy giant Enron say its total legal and accounting costs since declaring bankruptcy may top $1 billion by 2006, according to a newspaper report.
SmartPros, November 14, 2003 --- http://www.smartpros.com/x41372.xml 

Tyco International Ltd., dogged by a series of scandals and eager to polish its image, is putting its entire workforce through a training program on legal and ethical issues. Can you teach someone ethics? A trend worth keeping an eye on, maybe a new service offering! 
AccountingWeb, November 13, 2003 --- http://www.accountingweb.com/item/98335 

If PT Barnum was right when he said "There's a sucker born every minute.", there ... to use it My habit is to underestimate the weasels and overestimate the eagles ..
An ebook by Matthew Saul --- http://www.jwp.bc.ca/saulm/nn/ebook.pdf 

"Our study demonstrates that audit firms may lie to keep a profitable audit client if the expected benefits of keeping the client happy outweigh the expected costs of an audit failure if the firm gets caught," said Debra Jeter, co-author of the study and an associate professor of accounting at the Owen Graduate School of Management at Vanderbilt.
(See below.)

Recall that the majority of U.S. large corporations are chartered in Delaware largely because it is easier to do there..
This is a big deal, and not just for Disney. Judge Chandler's opinion has put directors of public companies on notice that the courts in Delaware, where more than half of the FORTUNE 500 are incorporated, are inclined to hold them to a higher standard of performance than has been expected in the past. Boards have enjoyed virtually unlimited protection from lawsuits, particularly on the issue of executive pay—until now. Says Scott Spector, a partner in the corporate group of the Silicon Valley law firm of Fenwick & West: "This case has tremendous importance at a time when executive compensation is under intense media and shareholder scrutiny."
See Marc Gunther's Mickey Mouse article below.

Former HealthSouth executives gave themselves over $500,000 of company money to pay for legal fees shortly before pleading guilty to defrauding shareholders.
The Wall Street Journal, November 3, 2003 --- http://online.wsj.com/article/0,,SB106781877480439600,00.html?mod=home_whats_news_us 

Fannie Mae had losses of $237 million from soured mortgage investments during the first nine months of 2003, with nearly half of the losses coming from its portfolio of manufactured-housing loans, according to a new federal filing.
Patrick Barta, The Wall Street Journal, November 17, 2003 --- http://online.wsj.com/article/0,,SB106902254027452700,00.html?mod=home%5Fwhats%5Fnews%5Fus 
Bob Jensen's threads on the accounting scandals at big Fannie and her brother Freddie Mac are at http://www.trinity.edu/rjensen/caseans/000index.htm 

HEIRESS IN HANDCUFFS Lea Fastow is charged with helping husband Andy orchestrate the white-collar crime of the century. Now she could be the key to nailing Enron's top dogs.
November 14, 2003 message from BusinessWeek Online's Insider [BW_Insider@newsletters.businessweek.com]
(See below) 

Billions of dollars of life insurance cash values may be in big trouble, and most consumers don't know it because they don't check their policies like they do their stocks and bonds.
AccountingWeb, November 11, 2003 --- http://www.accountingweb.com/cgi-bin/item.cgi?id=98308 

About 450 securities firms will contact mutual fund investors over the next three months about possible refunds totaling at least $85 million. 
AccountingWeb, November 11, 2003 --- http://www.accountingweb.com/item/98330 

A Million Here, A Million There:  Where's the real benefit?
TIAA-CREF CEO Allison to Get At Least $9 Million This Year
Arden Dale and Yuka Hayashi, The Wall Street Journal, November 10, 2003
Mr. Allison's compensation package at TIAA-CREF is substantially larger than that of his predecessor, John Biggs, who retired last year.  Mr. Allison's compensation includes $1 million in annual salary, a performance bonus of at least $3 million, and a long-term compensation award of $4 million, payable at the end of 2005.

University CEOs Get Peanuts in Comparison
4 Highest-Paid (Private) University Presidents Top $800,000 a Year 
by Tamar Lewin, The New York Times, November 10, 2003 --- http://www.nytimes.com/2003/11/10/education/10PAY.html 
Bob Jensen Note:  Detailed comparisons are impossible, because no two CEOs of colleges and universities receive the same benefits packages in terms of houses, cars, travel (such as tag along trips on private jets of members of the Boards of Trustees,, deferred compensation, etc.  There are no stock options, however, in not-for-profit organizations.

Four presidents of private universities were paid more than $800,000 last year, and the era of the million-dollar college president is fast approaching, according to an annual survey by The Chronicle of Higher Education.

Over all, 27 presidents of private universities earned at least a half-million dollars in the fiscal year, the same number as in the previous year.

The nation's highest-paid university president — Shirley Ann Jackson, who heads the Rensselaer Polytechnic Institute, in Troy, N.Y., — received $891,400 in pay and benefits in the last fiscal year, in addition to more than a half-million dollars for serving on corporate boards.

Gordon Gee of Vanderbilt University was paid $852,023, and Judith Rodin of the University of Pennsylvania received $845,474, about the same amount, including severance pay, that Arnold J. Levine earned at Rockefeller University when he stepped down last year after questions about his relationship with a female student.

At all the highest-paying universities, presidential compensation has increased at least twice as much as faculty pay over the last five years: at the University of Pennsylvania, however, from 2000-1 to 2001-2, the average professor's pay increased faster than President Rodin's compensation.

"It seems to me that the pay of faculty ought to be the benchmark," said Patrick M. Callan, president of the National Center for Public Policy and Higher Education in San Jose, Calif. "Even though the president starts at a higher level, there's no reason why the percentage increase for presidents shouldn't be the same as for faculty."

Public universities tend to pay their presidents substantially less than private universities, but the gap may be closing. According to this year's survey, 12 public university presidents — twice as many as last year — were paid more than $500,000.

"This is certainly not helpful at a time when public higher education is facing fiscal stringency, raising tuition by double-digit numbers," Mr. Callan said. "It's particularly hard for these high-paid presidents to go to the legislature and make the case for higher funding."

Mary Sue Coleman, who became president of the University of Michigan in August 2002, will get $677,500 this academic year, making her the highest-paid president of a public university. Just over a quarter of the public university presidents were paid more than $400,000, the survey found.

With many states raising tuition and slashing their budgets for higher education, legislators are showing increasing discomfort about the rising pay for college presidents. In Florida this year, legislators imposed a cap on the state's pay for public university presidents. And a bill under consideration in Ohio would limit the state contribution to university presidents' salaries to the $130,292 the governor earns. About a third of public university presidents received some of their pay from private sources, the survey found.

Presidential pay at the nation's liberal arts colleges is substantially lower. According to the survey, the highest-paid president of such colleges, Russell K. Osgood of Grinnell College, received $480,000 in pay and benefits, and only he, Larry P. Arnn of Hillsdale College and Nancy S. Dye of Oberlin College earned more than $400,000.

(Cornell's) President reports progress with faculty salaries improvement plan 
 Jacquie Powers, Cornell Chronicle, April 17, 2003 --- http://www.news.cornell.edu/Chronicle/02/4.18.02/salaries.html 

Cornell has made substantial progress in its multi-year faculty improvement plan, with salaries for continuing faculty increasing 8.1 percent in 2001-02, compared with the university's overall goal of 8 percent, President Hunter Rawlings announced April 17.

Endowed college salaries increased 7 percent in 2001-02, the single largest increase in its selected peer group, Rawlings said. The peer group average was 4.4 percent, according to preliminary data from the American Association of University Professors (AAUP).

Cornell contract college salaries increased by 6.5 percent in 2001-02, the second largest percent increase in the selected peer group, behind Texas A&M. The peer group average increased by 2.6 percent, largely attributable to very modest increases in many of the public institutions, Rawlings said.

Continued in the article

College salaries lacking in logic
Linda Conner Lambeck, Connecticut Post, November 4, 2003 --- http://www.yourct.com/moneynews/1881/ 

If the latest published salaries of area private college presidents were based on longevity, the Rev. Aloysius P. Kelley, Fairfield University president since 1979, would be making the most instead of the least.

If based on revenues generated, John L. Lahey, president of Quinnipiac University, which grossed $113 million in 1998-99, would not have made $31,000 less than Anthony J. Cernera, president of Sacred Heart University in Fairfield, where revenues were $72 million in that year.

And if enrollment were the deciding factor, Lawrence DeNardis, president of the University of New Haven, wouldn't have made less than Julia M. McNamara, president of Albertus Magnus College in New Haven, or then-University of Bridgeport President Richard Rubenstein. Both led institutions with half the enrollment of UNH's 5,000 in 1998-99.

There are no hard-and-fast rules in setting the salary of college presidents. Generally it depends on what the board of trustees decides to pay and what the president is willing to accept.

Continued in the article.

A Billion Here, A Billion There:  Where's the real money?
An EDS accounting change over revenue booking wiped out $2.24 billion in past profits at the computer-services company.
Gary McWilliams, "EDS Cuts Profits Of $2.24 Billion For Rule Change," The Wall Street Journal, October 29=8, 2003 --- http://online.wsj.com/article/0,,SB106728827489759900,00.html?mod=technology_main_whats_news 
Bob Jensen's threads on revenue accounting are at http://www.trinity.edu/rjensen/ecommerce/eitf01.htm 

The General Accounting Office issued a scathing report on the federal civil rights commission, saying the director of the agency's staff flouted government guidelines while managing a $9 million budget, particularly while letting contracts worth more than $25,000.
SmartPros, November 10, 2003 --- http://www.smartpros.com/x41314.xml 

Sounds Corny
Federal regulators have told Frito-Lay, Inc., Kraft Foods Inc. and Dean Foods Co. that they are considering legal action against the companies, claiming that they helped a grocery distributor that filed for bankruptcy protection earlier this year speed up the booking of revenue.
SmartPros, November 10, 2003 --- http://www.smartpros.com/x41298.xml 
Bob Jensen's threads of revenue accounting frauds are at http://www.trinity.edu/rjensen/ecommerce/eitf01.htm 

Vanguard also is cracking down on companies that pay their auditors less for their audit than for other services such as consulting. "We want companies to spend more for their audit than for everything else," says Glenn Booraem, who heads Vanguard's corporate-governance effort. And Vanguard voted against any directors that served on audit committees that didn't meet the firm's standard on auditor pay.
Ken Brown (see Vanguard article below)

Long Quote from Professor Steve Zeff
Few would deny that the U.S. accounting profession is in a very troubled state.  The aim of this two-part article is to explain how and why the profession evolved and changed during the 20th century, with particular emphasis on the last three decades.  It is my hope that this article will illuminate the origins and consequences of these changes that collectively brought the profession to its current condition.

This paper reviews, examines, and interprets the events and developments in the evolution of the U.S. accounting profession during the 20th century, so that one can judge "how we got where we are today."  While other historical works study the evolution of the U.S. accounting profession,¹ this paper examines two issues: (1) the challenges and crises that faced the accounting profession and the big accounting firms, especially beginning in the mid-1960s, and (2) how the value shifts inside the big firms combined with changes in the earnings pressures on their corporate clients to create a climate in which serious confrontations between auditors and clients were destined to occur.  From available evidence, auditors in recent years seem to be more susceptible to accommodation and compromise on questionable accounting practices, when compared with their more stolid posture on such matters in earlier years.
"How the U.S. Accounting Profession Got Where It Is Today: Part I," by Stephen A. Zeff, Accounting Horizons, September 2003, pp. 189-205.

Note from Bob Jensen
Steve's main points are consistent with Art Wyatt's remarks at the 2003 AAA Annual Meetings in Hawaii.  However, Steve fleshes in more of the historical detail.  I am really looking forward to Steve's forthcoming Part II continuation.

I might elaborate a bit on Steve's assertion that:  "From available evidence, auditors in recent years seem to be more susceptible to accommodation and compromise on questionable accounting practices, when compared with their more stolid posture on such matters in earlier years."  Out of context, this implies that auditors of old were more moral, ethical, and professional.  But such behavior in context is relative to the changing pressures, temptations, and opportunities of a changed auditing environment.

Just because all the "stolid" male (virtually all were male before the 1970s) auditors decades earlier never committed adultery with Elizabeth Taylor does not mean that they were above temptation.  Such temptation never came their way, because Elizabeth Taylor in her prime never had any inclination toward auditors (sigh).  Along a similar vein, these "stolid" auditors only appeared to be less "susceptible to accommodation and compromise on questionable accounting practices" because temptations, pressures, and opportunities in the 1960s and earlier were totally unlike the auditing climate of the 1980s and 1990s.  My point is that auditors are human beings who have changed much less than the temptation environments and contractual complexities within which the audits take place.  The same thing has happened in the profession of journalism in the age of technology, and I highly recommend the professionalism concerns voiced at http://www.journalism.org .  Journalists have not changed nearly so much as the journalism environment in the age of technology and civil strife around the world.

I also get riled when some analysts (not Steve) suggest that accounting principles today are too complex and that the simpler standards of the 1960s and earlier are all we need for current financial reporting purposes (e.g., see Scott McNealy's recommendations below ).  Those simpler standards never envisioned contractual complexities of the 1990s when newer types of derivative financial instruments (e.g., swaps), newer types of off balance sheet ploys (e.g., variable interest entities), and compound debt/equity instruments were invented.  Old standards are no more effective in modern accounting any more than battleships are effective in an age of nuclear submarines, laser-guided missiles, and satellite tracking systems.  My point here is that the FASB and IASB standards of the 1990s and later are complex because the contracts being accounted for became so complex.  There are no simple solutions to complex contracting except for simplistically naive fair value solutions that are out of touch with reality.  

November 6, 2003 reply from Gerald Trites [gtrites@STFX.CA] 

I recently read with great interest the Zeff paper in Horizons, the first part of a two part paper on the slow decline of the profession - or perhaps more accurately, its transition from profession to industry - during the 20th century.

Having lived through a good part of the period he covered in the first part, I can say it does a remarkable job of capturing the essence of the events during the period - a period characterized by by the inexorable forces on the profession by its publics, and the abandonment of professionalism for commercialism.

The papers should be required reading for every young person who wishes to obtain a professional accounting designation and the subject of discussion and debate in classrooms.

There was a recent cartoon in the New Yorker where an executive was sitting at a boardroom table with other executives and saying "The auditors are not team players any more." We can only hope. I hope this is the beginning of a return to professionalism. Maybe educators can help to make it so.

And congratulations to Professor Zeff.

Jerry Trites

November 6, 2003 reply from Amy Dunbar [Amy.Dunbar@BUSINESS.UCONN.EDU] 

Zeff's piece is great, and I look forward to the second part. The blinders came off my eyes with respect to our profession (I previously thought it was a few bad apples) when I listened to the tax shelter testimony live on Oct. 21 via Realplayer (ah, the wonder of technology). The testimony is available on http://www.senate.gov/~finance/sitepages/hearing102103.htm . In particular, the PCAOB testimony is interesting. I now think that public accounting firms should not be able to audit clients that have purchased a "no business purpose" tax shelter from the audit firm. Perhaps the solution is to say that if the corporation is a tax client, you can't audit the company. That solution is overkill, but I no longer trust the firms to judge "business purpose." I have asked my graduate tax students to write their last memo on what Congress should do to address the tax shelter issue. The memos should be interesting reading.

Sansing, ever the terse analytic, would agree with the former IRS Chief Counsel, B. John Williams, who said the following, "One of the foundation stones of the credibility of the Service with the American public is that the Service proceed analytically rather than emotively. 'Abusive' reflects the indignation that the Service feels about a transaction, but the Service's feelings about a transaction do not state a legal basis for disallowing the tax benefits from a transaction. 'Abusive' is not an analytical term, it is an emotive term, and the mission of the Service is to apply the law fairly and impartially, not to apply the law in a manner that is biased toward a result the government wants."

Dunbar, ever the emotional observer, would encourage a little righteous indignation. Good heavens! Read the testimony of Henry Camferdam (someone said he was on 60 Minutes). When did our profession lose its way? Read Zeff!

Amy Dunbar 
UConn

November 6, 2003  Reply from Paul Williams [williamsp@COMFS1.COM.NCSU.EDU] 

For those of you are members of the Public Interest Section of the AAA and have free access to the section journal, Accounting and the Public Interest, there is an excellent article by Tony Tinker that sheds considerable light on this notion of the "decline of the profession." It's a myth because it presumes there was a golden era of the profession when it performed in some ideal, Durkheimian sense. But the profession of accounting was never very high up in a place it could decline from. Tom Lee documents that the first chartered accountants (ever) in Scotland (the primordial swamp from which all CPAs emerged) garnered their "charter" in order to restrain trade for their services -- they were a rather unsavory bunch whose motivation for creating the "profession" was hardly to serve the public interest. The only way accounting could ever be a profession in the classical sense in which we seem to be speaking of it as a service to mankind is that its service be performed in the employee of mankind, not in the employee of sizable private interests that are not nearly as politically and socially benign as Adam Smith's baker.

November 6 reply from Bob Jensen

Hi Paul,

With due respect, I think there was a "Golden Age" period where professionalism was quite high. I would argue that it was in the early part of the 20th Century when the large firms were formed by high integrity professionals with names like Andersen, Ernst, Haskins, Sells, Ross, Lybrand, etc. These were extremely high integrity professionals who set tough tones at the top for their employees, especially the outstanding Norwegian (my hero) named Arthur Andersen.  Read part of the eulogy for Arthur Andersen, delivered on January 13, 1947 the Rev. Dr. Duncan E. Littlefair --- http://www.trinity.edu/rjensen/fraud.htm 

Interestingly, the early public accounting firms may have had the highest integrity between 1900 and 1933 when auditing was not required by the U.S. Government, and CPA's did not have an auditing monopoly. I think that the early firms really believed their futures depended upon integrity and quality of service since the decision to have an audit was discretionary in the sense of agency theory where having an audit generally added value to share prices vis-à-vis not having an audit. 

As I have indicated elsewhere, however, this does not mean that "stolid" (Zeff's term) auditors of the 1950s, 1960s, and 1070s who seemingly remained highly professional would have blown the whistle on Enron, Worldcom, Xerox, Sunbeam, etc. in recent years. My comments on this are given at http://www.trinity.edu/rjensen/fraud123103.htm 

We have also had some outstanding auditors who worked public servants in government. But in the U.S., the least professional and most greedy leaders are generally in the top tiers of government (Congress, Senate, Executive Cabinet, etc.) These powerful individuals, in turn, exert pressure on agencies like the FDA, FTC, FPC, FAS, SEC, etc. to serve the interest of the companies rather than the public.

Where are the biggest crooks in most nations? Generally in high levels of government. Hence, I would prefer not to look to government for people committed to "service (as) an employee of mankind."

Where does one find an "employee of mankind?" (a Tony Tinker term) In my opinion, an employee of mankind is a high integrity professional who is driven by inner morality forces no matter where she/he happens to be employed (public or private). Public accounting in theory is neat, because the integrity is more necessary to survival of the profession than in other professions that sell more than integrity.

The problem is really not one of organizational structure. It is one of slight moral decay in the midst of enormous increases in temptation. I suspect the rise in temptation and opportunity are the main culprits.

In the next edition of New Bookmarks, I will have more to say about how this problem will be corrected. Look for the heading "1984+50: Screwed and Tattooed" in the forthcoming edition of New Bookmarks (probably around October 20).

I just finished watching the AICPA's excellent FBI Webcast today (Nov. 6). One segment that I really enjoyed was a video of Walter Pavlo, a former MCI executive who served prison time for fraud. This was a person with all intentions of being highly professional on a fast track to being in charge of collecting reseller bad debts for MCI. In that position, he just stumbled upon too much temptation for what is tantamount to a kiting scheme.

You can read details about Walter Pavlo's fraud at http://www.forbes.com/forbes/2002/0610/064.html  This Forbes site was temporarily opened up for the AICPA Webcast viewers and will not be available very long. If you are interested in it, you should download now!

The FBI agents in the Webcast made a careful distinction between career con artists (who jump from con to con before and after prison because they seem to be inherently addicted to the game) versus others who commit fraud as a result of opportunity and temptation that exceeds their will power. These agents suggested an analogy of a bag of money being found where there appears to be no possibility of being detected. People who would never steal might succumb to "finders keepers" temptations, especially if they thought the money was lost by drug dealers who had no legitimate claim to the money in the first place and needed to somehow be punished.

Morality has not declined in the professions nearly as much as temptations and opportunities have created new environments that test morality. An analogy here is pornography. Playboy Magazine thrived in the 1960s when there was little else boys could easily get their hands on to hide under the mattress (yeah I did that). These boys were more curious than addicted. In the 21st Century with millions of free pictures of the hardest core imaginable only a few mouse clicks away, temptations and opportunities have created an entirely new addiction environment for both young people and pedophiles that prey on the young.

The obvious solutions are to do our best to convince others (e.g., auditors) not to succumb to opportunity, but it is difficult to raise the morality bar. Another solution is to reduce the temptations by increasing the probability of getting caught (e.g., better controls). At this precarious juncture in the life of our profession, we need to concentrate on both alternatives. 

But it will be a sad day when we go too far, and I will have more to say about that in the next edition of New Bookmarks.

Bob Jensen

The remainder of this thread, including long and scholarly replies from Paul Williams and David Fordham are at http://www.trinity.edu/rjensen/fraud.htm#Professionalism 

Free Corporate Fraud Hotline Initiated February 2003: 888-622-0117 

• 2,000 calls logged within eight months.  
  

• Callers can be anonymous 
  

• Several new cases opened based on caller information 
  

• Several existing cases were enhanced 
  

• Public cooperation is essential

The European Union is setting up an agency to co-ordinate work to combat the rising tide of cybercrime.
BBC News, November 21, 2003 --- http://news.bbc.co.uk/2/hi/technology/3226178.stm 

An international crackdown targets hackers, software pirates, perpetrators of credit card fraud and other cybercriminals. Authorities say they found 125,000 victims who lost more than $100 million in Internet scams --- http://www.wired.com/news/business/0,1367,61317,00.html?tw=newsletter_topstories_html 

Bob Jensen's helpers for reporting crimes are at http://www.trinity.edu/rjensen/fraud.htm#ThingsToKnow 

"A Boss for the Boss," by Roger Lowenstein, The New York Times Magazine, December 14, 2003 --- http://www.nytimes.com/2003/12/14/magazine/14PHENOM.html 

''People being human, there will always be someone cutting corners and acting in their own self-interest,'' observes Ira Millstein, the lawyer most active in the suddenly trendy field of corporate governance. And so, regulators, investors, academics and even corporate directors are coming round to the idea that Millstein has been championing for two decades: a better way must be found to govern the corporation from within.

This intellectual ferment has upended life in that formerly cozy preserve known as the corporate boardroom. A transfer of accountability has occurred, a reapportionment of turf. ''People used to say problems were management's concern,'' Millstein says. ''When it comes to the scandals of the 90's, they are blaming the passivity of boards.'' These scandals are making plain the futility of merely blaming C.E.O.'s or even ''greedy C.E.O.'s.'' C.E.O.'s are greedy, often obscenely so. Presumably, they will be that way in 100 years. The question is not how to enlighten them, but how, and who, to restrain them.

It may seem curious that no one, until recently, thought that it was a matter for directors or fretted if a chief executive stacked his board with friends. The Disney board once included Michael Eisner's lawyer, his architect and the principal of his kids' school. With this type of oversight, C.E.O.'s could do no wrong. Consider Tyco, whose chief executive, L. Dennis Kozlowski, is now on trial for stealing from his shareholders. In 2001, shortly before his supposed crimes came to light, Kozlowski demanded a contract that guaranteed his severance, even if he committed a felony. The directors might have reasonably asked if Kozlowski were plotting a little arson or, perhaps, a discreet murder. Instead, they met his terms.

Nell Minow, a shareholder activist, says no board would grant such a blank check today, and not only because the rules for directors have changed. The culture is also changing. ''It used to be considered rude to ask a question,'' she says. ''Now they are all vying to ask the toughest question.''

Optimism must be tempered by the experience of two prior periods of activism, neither of which solved the governance riddle. There is a metaphysical sense in which the problem is irresolvable. Plato argued for a society run by perfect guardians; Juvenal is said to have replied, ''And who will guard the guardians?'' That has always been the dilemma

Continued in the article

Related issues --- http://www.trinity.edu/rjensen/FraudConclusion.htm 

The Institute of Management Accountants (IMA) launched its Sarbanes-Oxley Knowledge Network http://www.imaknowledge.org/sox 

December 3, 2003 message from Colleen Sayther [mailmanager@feiexpress.fei.org] 

KPMG Fraud Survey
Provides detailed examination of fraud, new anti-fraud measures, and how organizations will manage this pervasive problem in the future. Over 450 U.S. business executives and government officials were interviewed to help determine how organizations are confronting fraud in the post-Sarbanes-Oxley era. The results produced several interesting insights. Click on the link for a full copy of the study.

The URL is http://www.fei.org/download/Fraud_12_2_03.pdf 
This is a large file that may not download on slow modems.

---

Finance & Accounting Outsourcing
Challenged by an unsteady global economy, pressure to deliver more shareholder value, and hyper-scrutiny from inside and out, CFOs now bear the weight of increased accountability and liability. The need for CFOs to contribute strategic value equals the demand for timely, accurate financial information at lower cost. Outsourcing accelerates cost and process improvements while delivering best practice expertise. Cap Gemini Ernst & Young addresses these topics in their ExecutiveEdge, Reduce Costs and Improve Performance-Simultaneously. Click here to access.

The URL for various Cap Gemini downloads is at http://www.us.cgey.com/ind_serv/services/outsourcing/info_research.asp 

Question
What does yield burning mean?

Answer

"IRS Examines Derivatives Schemes." by John Connor, The Wall Street Journal, December 4, 2003 --- http://online.wsj.com/article/0,,SB107049507430505200,00.html?mod=mkts_main_news_hs_h 

The Internal Revenue Service is investigating the use of derivatives to implement suspected "yield-burning" schemes in the municipal-bond market.

In addition, the agency is seeing instances of apparent bid-rigging of derivatives, a senior IRS muni-enforcement official said.

The IRS several years ago joined with the Securities and Exchange Commission and the Justice Department in taking enforcement action against many Wall Street and regional brokerage firms for alleged yield-burning abuses -- slapping excessive markups on Treasury securities used in escrow accounts created in connection with muni advance refunding transactions. These deals were done in the early 1990s.

The new crop of transactions under scrutiny seem to be from 1998 forward, IRS officials said. The SEC also is investigating some of these transactions, according to people familiar with the matter.

A common denominator in these more recent transactions is the use of derivatives -- financial contracts whose value is designed to track the value of stocks, bonds, currencies, commodities or some other benchmark -- to divert arbitrage profits to investment bankers and lawyers, said Mark Scott, director of the IRS's tax-exempt bond program.

Arbitrage is generally barred in the muni market, where it is earned by investing tax-exempt bond proceeds in higher-yielding instruments. Arbitrage profits are supposed to be rebated to the Treasury Department. Yield-burning is a form of arbitrage abuse.

The IRS's Mr. Scott said it's not yet clear how pervasive the new, derivatives-related abuses are. But he said, "We are finding more problems than I expected." He said the agency's investigation is expanding.

One specific concern involves the use of put options in advance-refunding escrow accounts. A put option is a provision in a bond contract under which the investor has the right -- on specified dates after required notification -- to return the securities to the issuer or trustee at a predetermined price.

"Recent examinations involving advance-refunding bonds with put options in the escrow highlight increasing concerns about the use of derivative-type products as a more-sophisticated yield-burning or general abusive arbitrage scheme," said Charles Anderson, manager of the IRS's tax-exempt-bond field operations. "In the case of a put-option escrow, there is simply no reasonable need for the purchase of a put in an escrow that is already sufficient for defeasance of earlier bonds." He said that "any time people can sell products paid for with money normally rebatable to Uncle Sam, you will see the sharks circling."

Messrs. Scott and Anderson declined to comment on specific cases or securities firms or law firms.

The IRS settled at least one put-option escrow case recently and is inviting parties involved in similar deals to come forward and seek settlements through the agency's voluntary closing agreement program.

Bob Jensen's threads on derivatives are at http://www.trinity.edu/rjensen/caseans/000index.htm 

Bob Jensen’s threads on “rotten to the core” are at http://www.trinity.edu/rjensen/fraud.htm#Cleland 

"The Accounting Cycle Does Senator Enzi Support Accounting Lies? by J. Edward Ketz, SmartPros, November 24, 2003 --- http://www.smartpros.com/x41471.xml 

I continue to find amazing some public statements enunciated by members of Congress. It reminds me of the witticism to be sure that your brain is engaged before putting your mouth into gear.

Consider recent comments by Senator Mike Enzi (R-Wyoming), who is holding hearings to allow small business executives to spout off against accounting reform. Specifically, these managers are yet again attempting to thwart the the Financial Accounting Standards Board's efforts to require the expensing of stock-based compensation. Of course, they covet the privilege of abusing corporate resources instead of acting as good stewards for the owners -- the stockholders of the business enterprise.

The Washington Post reports that the senator berated the chairman of the FASB Robert Herz with the comment, "I’m hoping small businesses don’t have to wage an 11th-hour campaign to get FASB to listen." He also chided Herz to contemplate the effects upon small businesses. Oddly, the senator didn’t advise Herz to ask investors and creditors about the consequences of poor and reprehensible accounting practices.

These corporate officials provide no new arguments or theories to bolster their claims, but rely on vacuous assertions. They claim that expensing options will hurt their search for talented managers, but cannot generate any evidence to that effect. Given that Microsoft now expenses stock-based compensation and appears not to have troubles hiring good people, I believe the assertion false.

Continued in the article

Bob Jensen's bottom line commentary is at http://www.trinity.edu/rjensen/FraudConclusion.htm 

November 19, 2003 message from Colleen Sayther [mailmanager@feiexpress.fei.org] 

FEI's annual Current Financial Reporting Issues conference, Integrity in Action, kicked off Monday morning with SEC Chairman William Donaldson. He focused most of his remarks on corporate governance and restoring confidence in the stock markets. The recent wave of corporate scandals, he told an overflow crowd of more than 850 financial executives at the New York Hilton, "has severely undermined the reputation of U.S. business, and represents a fundamental betrayal of American investors." At the same time, "the public sees a rigged game for insiders and the privileged."

Donaldson, who took office earlier this year, argued that a modest reform effort would be a mistake, and that the future of American business "relies on going beyond perfunctory compliance" with new rules like Sarbanes-Oxley.

The SEC chairman noted that the SEC had filed almost 700 actions in the fiscal year ending this past September, up more than 50 percent from the previous year, and that it intends to beef up enforcement and make the proceeds of fines "available to harmed investors." More than 800 professionals will be added to the current base of 3,200 staffers, he added, calling it a "major, major undertaking" to attract good people and get more synergy among the SEC's major divisions.

Key areas in the coming months, Donaldson said, would include a focus on: 1) late trading and market-timing in mutual funds; 2) monitoring corporate governance reforms at regulated institutions like the New York Stock Exchange, where a major overhaul is underway; and 3) enhancing disclosure of the nominating process for corporate directors and ensuring more shareholder input into that process.

Asked if anything can be done about the markets' unending focus on quarterly earnings, Donaldson argued that earnings management has been in a "strait-jacket" that insists on constant incremental growth. Financial managers, he said, need to "refuse to take advantage of the opportunities to conform" to those expectations -- implying that companies, and not investors, need to take the lead in creating change.

October 15, 2003 message from Thomas Buchman [Buchman@colorado.edu] 

Hey Bob:

I found this web page last night, have you seen it? tb

http://www.quatloos.com/ 

Thomas A. Buchman 
Associate Professor of Accounting 
Leeds School of Business 
419 UCB 
University of Colorado 
Boulder CO 80309-0419 U.S.A.

Recently at an open meeting, the Securities and Exchange Commission (SEC) adopted rules that will improve disclosure to investors regarding the nominating committee processes of public companies and the ways by which security holders may communicate with directors at the companies in which they invest. http://www.accountingweb.com/item/98380 

Hi Hossein,

Aside from my tongue in cheek fashion quip about "green eyeshades with matching white gloves," I think it should be stressed that CPA firms that offer a wider range of assurance services do not necessarily employ accountants for some of these services. In fact, accountants are probably not even trained for some assurance services in areas of elder care, computer security, city development, etc.

The theory as expounded over and over by Bob Elliott, who led the AICPA into the assurance services idea, is that the reason clients want CPA firms to deliver assurance services is the high trust those clients have in the integrity and professionalism of CPA firms. To the extent that recent and highly publicized auditing scandals have not destroyed public faith in CPA firms' integrity, there's still a glimmer of hope.

Public faith in CPA integrity is more essential for assurance services since most of these client engagements are voluntary. As long as CPA firms hold a monopoly on auditing services, it is possible to absorb more media shock of auditing scandals on the short term. CPA firms must place top priority on getting their reputations in order, however, for the long haul. A former top official of the SEC informed me privately that he anticipates the collapse of one more of the Big Five leaving us with a Big Three.

Reports that major firms have not really changed their ways in audit engagements are disturbing.

"Our study demonstrates that audit firms may lie to keep a profitable audit client if the expected benefits of keeping the client happy outweigh the expected costs of an audit failure if the firm gets caught," said Debra Jeter, co-author of the study and an associate professor of accounting at the Owen Graduate School of Management at Vanderbilt --- http://www.trinity.edu/rjensen/fraud123103.htm 

What is most disturbing to me in the recent HealthSouth revelation (that the auditing CPA firm earned much more from its Elder Care Assurance Service engagement than its audit engagement at HealthSouth) is that the magnitude of the combined revenues made the audit firm's local office more dependent upon keeping that "client happy" in the context of the above quotation from Debra Jeter. My worry is not so much the possibility of conflict of interest as it is revenue dependence from a relatively big client at the local office level.

Bob Jensen's threads on the wave of scandals can be found at http://www.trinity.edu/rjensen/fraud.htm 

Bob Jensen

-----Original Message----- 
From: Hossein Nouri [mailto:hnouri@TCNJ.EDU] 
Sent: Thursday, November 13, 2003 
Subject: Re: Are the toilets audited at Trinity University?

First of all, this not something that we can hide from students. Sooner or later they will know about it. In fact, I just sent it to my entire auditing class and told them we will discuss it in the next class!

While everybody seems to be upset about this (including myself) and looks at it in a negative way, we could also positively discuss this toilet audit. I am upset because it seems to be more of a scandal than a service audit. But, if auditors can provide services that benefits people who can be abused (like elderly people), I actually think that is a good professional service. And if you think that elderly people cannot be abused or their living conditions are good, I suggest you make a few visits, as volunteers, to some of these elderly facilities. I personally salute auditors who professionally perform the services that are to the best interest of the overall society (For your information, I am not performing such services!).

On a side note, I have not heard other professionals complain about the type of jobs they do. For example, your family doctor examine your rectum for prostate cancer. To me if this is not worse than examining toilet, it is at the same level.

If you have other positive thinking that I can tell to my class, I would like to hear from you.

Hossein Nouri, Ph.D., CPA, CFE, DABFA, 
CFSA School of Business 
The College of New Jersey 
PO Box 7718 Ewing, NJ
Email: hnouri@tcnj.edu 

FAS 133 Trips Up Freddie Mac

Freddie Mac named Richard Syron, a former head of the American Stock Exchange, the Boston Fed, and tech firm Thermo Electron, as its new chairman and CEO. The executive succeeds Greg Parseghian, who was asked to step down after federal regulators determined he played a role in a string of accounting misdeeds.
See "Freddie Mac Appoints New Chief:  Syron May Bring Stability To Beleaguered Company; Toughness Is Questioned," by Patrick Barta and John D. McKinnon, The Wall Street Journal, December 8, 2003 ---  http://online.wsj.com/article/0,,SB107081511244443300,00.html?mod=home_whats_news_us 

Although nobody has yet to write up a case on Freddie Mac, the Appendices at this Freddie Mac site are a derivatives accounting education in and of themselves --- .  The link with the appendices is at http://www.freddiemac.com/investors/restatement/ 

"Freddie Mac hit with fine," by Marcy Gordon, The San Antonio Express News, December 11, 2003 --- http://news.mysanantonio.com/story.cfm?xla=saen&xlb=110&xlc=1097161&xld=110 

Freddie Mac is paying a $125 million civil fine and is being threatened with possible curbs on its growth as federal regulators blame management misconduct for the mortgage giant's $5 billion misstatement of earnings. In a report issued Wednesday, regulators accused the government-sponsored company of violating its public trust.

A pliant board of directors and a system of compensating executives tied to annual earnings