What Can We Learn From Enron?

Bob Jensen at Trinity University

This document was prepared for the opening plenary sessions on September 30, 2002 and November 21, 2000 at the 32nd Virginia Accounting and Auditing Conference co-sponsored by the Virginia Society of CPAs and Virginia Tech at the Hotel Roanoke in Roanoke Virginia.  It was later updated for a presentation at Kent State University on April 24 at the IMA Annual Professional Development Conference.

This paper's evolving draft form is at http://www.trinity.edu/rjensen/fraudVirginia.htm 

Bob Jensen's more extensive documents on recent accountancy scandals can be found at http://www.trinity.edu/rjensen/fraud.htm 


Background Links for This Document

Issues in the accounting, finance, and business scandals --- http://www.trinity.edu/rjensen/fraud.htm

Bob Jensen's threads on professionalism and independence are at  http://www.trinity.edu/rjensen/fraud.htm#Professionalism 

Bob Jensen's threads on pro forma frauds are at http://www.trinity.edu/rjensen//theory/00overview/theory01.htm#ProForma 

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



I am honored to be invited to such a large gathering of professional accountants and educators from the State of Virginia.  I am also honored to be a co-speaker in this opening plenary session with Art Wyatt.  I have always held Dr. Wyatt in awe for his encyclopedia-like recall of accounting standards and his enormous contributions to both the practice and academic sides of accountancy.  He was and still is deserving of his honor of being admitted to the Accounting Hall of Fame along with another great accountant in the Accounting Hall of Fame named Arthur Andersen.

First on the Alphabetical Listing of Hall of Fame Inductees
ARTHUR EDWARD ANDERSEN Hall of Fame Site --- http://fisher.osu.edu/acctmis/hall/members/andersen.html 

Last on the Alphabetical Listing of Hall of Fame Inductees
ARTHUR RAMER WYATT Hall of Fame Site --- http://fisher.osu.edu/acctmis/hall/members/wyatt.html 

At least from an alphabetical listing of inductees to the Accounting Hall of Fame, we have the Alpha and the Omega who were both executive partners and great leaders in the great public accounting firm once known as Arthur Andersen & Company and later shortened to Andersen.  Although these two executive partners served over different time frames, both served as models of integrity, skill, and professionalism.  I thought this made a nice introduction, although as soon as the caretakers at Ohio State University add Year 2002 inductee Steve Zeff (Rice University) to the Hall of Fame Website, the Omega will be passed on to Dr. Zeff in the alphabetized listing.

It is sad that we must today address the sickening downfall of that great firm that Arthur Andersen (founder) and Arthur Wyatt both served so faithfully long before its downfall in the Year 2002 after its spectacular rise to international fame and fortune across the years 1913 to 2002.  Although the firm still exists on paper, it is virtually reduced to Ground Zero and is no longer allowed to perform audits as a public accounting firm.

The implosion of Enron was the catalyst that caused the Andersen firm to explode, but Andersen's demise was probably inevitable as a result of the failure of its leading partners over the past ten years to defuse the bomb that was heating up following a succession of scandalous audits such as Waste Management, the Baptist Foundation, Sunbeam, and others in which its reputation was blackened and its litigation reserves were drained.  

The Enron scandal is being blamed for the fall of Andersen.  Indeed the shredding of Enron audit working papers and communications led to the conviction on grounds of obstructing justice.  But in many ways, subsequent scandals such as the unbelievably bad audit of World.com by Andersen are more revealing of the shoddy and possibly fraudulent audits by Andersen in recent years.  These are audits that are totally out of line with the high integrity and professional standards that our two Arthurs (Andersen and Wyatt) set for this accounting firm in earlier years.

What is even more sad is that the decline in integrity and professionalism in large auditing firms was the rule rather than the exception in all the big auditing firms over the past two decades.  Since the early 1990s, lawsuits have revealed a decline in professionalism and integrity that accompanied spectacular growth in revenues in all these firms.  The growth in billions of revenues made it possible to pay out numerous millions in lawsuit judgments.  Many of the audit and consulting scandals are documented at http://www.trinity.edu/rjensen/fraud.htm 

Every large public accounting firm was a bomb waiting to explode like Andersen exploded.  In fact, the explosion of Andersen may have been the only thing that awakened the other firms in time to save themselves from the culture change in public accounting that is revealed by Paul Volker.  

Efforts to date by public accounting firms, the SEC, and the AICPA have not stemmed the tide of public opinion and despair.

  • What is so sad is that the "A" of accounting is now being worn like a Scarlet Letter A.  
  • CPA now means "Current Prison Adventure."  
  • Accountants seem unable to provide a product (Transparent, Timely, and True financial reports) that the public really wants.  
  • Leading auditors firms and the AICPA lobbied intensely with Congress in an effort to stack the Public Company Accounting Oversight Board with politically correct appointments.  Media accusations of such lobbying ultimately led to the resignations of Harvey Pitt (Chairman of the SEC), Robert Herdman (Chief Accountant of the SEC), and William Webster (the Pitt/Herdman choice for Chairman of the new PCAOB).   The public now perceives the disgraceful lobbying efforts of leading accounting firms and the AICPA as clear evidence of hypocritical behavior in preaching virtue and practicing vice.
  • Some leading audit firms like Andersen uncovered frauds but failed to place investor interests above their own interest in maintaining the flow of large audit fees.  Know examples include Waste Management and Enron.  Suspected examples of similar failures to protect investors are now in litigation for virtually all large auditing firms.  CPAs are losing the public opinion war from a public that demands action to speak louder than words.
  • For many years FASB stacked the Emerging Issues Task Force (EITF) with auditors and preparers, but allowed no representatives drawn from investors and analysts.
  • New compensation contracts with corporate executives reveal that no lesson has been learned about greed in the signing of new deals with ever-soaring salaries, options, and golden parachutes. 

What did we learn from the Enron and other recent scandals?

We learned that addicts cannot quit on their own!

We learned that corporate executives and accounting firms will not really change their ways unless investors themselves rise up in revolt by abstaining from corporate investing until executive compensation is more reasonable and a concerted effort is made for Transparent, Timely, and True financial reports.  

Bright light amidst this hypocrisy of reform

New York's Eliot Spitzer --- http://www.oag.state.ny.us/ 
The SEC would have not gone far investigating many recent spectacular frauds if Spitzer had not handed over the smoking guns.  This, in part, is due to hypocrisy in a government that that under funds the SEC enforcement budget while claiming to "get tough" on corporate corruption and security analyst frauds.

The Biggest Crime of All:  They Still Don't Get It 

"Wall Streets CEOs Still Get Fat Paychecks Despite Woes," by Susanne Craig, The Wall Street Journal, March 3, 2003

Chiefs' Packages Decline Overall Still, $10 Million or More Isn't Bad

Stock markets are down. Corporate public offerings are out. Investors are on the sidelines. And financial firms continue to cut staff.

 But there is still a bull market in one pocket of Wall Street -- the pay of securities-firm CEOs.

Amid one of the worst operating environments in years, Wall Street chief executives continue to pull down annual paychecks topping $10 million. Even though their pay is down overall, it is still turning heads in many quarters. Morgan Stanley's CEO Philip Purcell received a 2002 pay package of $11 million. Goldman Sachs Group Inc.'s Henry Paulson made $12.1 million and Lehman Brothers Holdings Inc.'s Richard Fuld took home a pay package valued at $12.5 million.


Citigroup Inc.'s Chief Executive Sanford I. Weill, whose banking firm has been dogged by regulatory probes this year, volunteered not to receive a cash or stock bonus for 2002 because the share price of the company, which owns Salomon Smith Barney, dropped 25% during the year.

But Citigroup's board granted Mr. Weill stock options for 2003 with an current estimated value of $17.9 million, more than the $17 million cash bonus Mr. Weill received in 2001. At Bear Stearns Cos., one of the few securities firms that actually saw its profit rise in 2002, CEO James Cayne saw his total compensation more than double to $19.6 million last year.


The still-hefty paychecks are drawing criticism as being out of whack with these tough economic times. On Wall Street, fees from the most profitable businesses -- such merger-and-acquisition advice and underwriting initial public offerings of stock -- have all but dried up.

"The problem is there is no strong indication the bear market is over and we are a long way from justifying these type of packages," says Mike Corasaniti, director of research at boutique investment firm Keefe, Bruyette & Woods Inc. and an adjunct professor in the business department of  Columbia University in New York .


"In good times boards justify the big pay packages by saying the executives are doing a great job and in bad times they justify the pay by saying they are managing in a difficult environment. No matter what, they seem to find a way to rationalize it."

Officials at the various firms declined to comment

Of course, a Wall Street CEO's pay is tied to performance. And the job hasn't been easy. But the tough decision to cut staff may have in fact boosted the pay packages of many top executives, as the cost-cutting measures kicked in. With the exception of a few firms, notably Credit Suisse Group's Credit Suisse First Boston, most Wall Street firms have actually been making money during the bear market. CSFB reported a loss for 2002 of $811 million, due to $813 million in charges to cover items ranging from 1,500 previously announced job cuts to a provision for civil-litigation costs.

Also see http://www.trinity.edu/rjensen//FraudConclusion.htm 

Lessons Learned From Paul Volker:  
The Culture of Greed Sucked the Blood Out of Professionalism
In an effort to save Andersen's reputation and life, the top executive officer, Joe Berardino, in Andersen was replaced by the former Chairman of the Federal Reserve Board, Paul Volcker.  This great man, Volcker, really tried to instantly change the culture of greed that overtook professionalism in  Andersen and other public accounting firms, but it was too little too late --- at least for Andersen.

The bottom line:

I have a mental image of the role of an auditor. He’s a kind of umpire or referee, mandated to keep financial reporting within the established rules. Like all umpires, it’s not a popular or particularly well paid role relative to the stars of the game. The natural constituency, the investing public, like the fans at a ball park, is not consistently supportive when their individual interests are at stake. Matters of judgment are involved, and perfection in every decision can’t be expected. But when the “players”, with teams of lawyers and investment bankers, are in alliance to keep reported profits, and not so incidentally the value of fees and stock options on track, the pressures multiply. And if the auditing firm, the umpire, is itself conflicted, judgments almost inevitably will be shaded. 
Paul Volcker (See below)

"Volcker says "new Andersen" no longer possible," by Kevin Drawbaugh, CPAnet, May 17, 2002 --- http://www.cpanet.com/up/s0205.asp?ID=0572

WASHINGTON, May 17 (Reuters) - Former Federal Reserve Board Chairman Paul Volcker, who took charge of a rescue team at embattled accounting firm Andersen (ANDR), said on Friday that creating "a new Andersen" was no longer possible.

In a letter to Sen. Paul Sarbanes, Volcker said he supports the Maryland Democrat's proposals for reforming the U.S. financial system to prevent future corporate disasters such as the collapse of Enron Corp. (ENRNQ).

"The sheer number and magnitude of breakdowns that have increasingly become the daily fare of the business press pose a clear and present danger to the effectiveness and efficiency of capital markets," Volcker said in the letter released to Reuters.

JUNE 25, 2002

How ironic that we are meeting near Arthur Andersen Hall with the leadership of the Leonard Spacek Professor of Accounting. From all I have learned, the Andersen firm in general, and Leonard Spacek in particular, once represented the best in auditing. Literally emerging from the Northwestern faculty, Arthur Andersen represented rigor and discipline, focused on the central mission of attesting to the fairness and accuracy of the financial reports of its clients. 

The sad demise of that once great firm is, I think we must now all realize, not an idiosyncratic, one-off, event. The Enron affair is plainly symptomatic of a larger, systemic problem. The state of the accounting and auditing systems which we have so confidently set out as a standard for all the world is, in fact, deeply troubled.

The concerns extend far beyond the profession of auditing itself. There are important questions of corporate governance, which you will address in this conference, but which I can touch upon only tangentially in my comments. More fundamentally, I think we are seeing the bitter fruit of broader erosion of standards of business and market conduct related to the financial boom and bubble of the 1990’s. 

From one angle, we in the United States have been in a remarkable era of creative destruction, in one sense rough and tumble capitalism at its best bringing about productivity-transforming innovation in electronic technology and molecular biology. Optimistic visions of a new economic era set the stage for an explosion in financial values. The creation of paper wealth exceeded, so far as I can determine, anything before in human history in relative and absolute terms. 

Encouraged by ever imaginative investment bankers yearning for extraordinary fees, companies were bought and sold with great abandon at values largely accounted for as “intangible” or “good will”. Some of the best mathematical minds of the new generation turned to the sophisticated new profession of financial engineering, designing ever more complicated financial instruments. The rationale was risk management and exploiting market imperfections. But more and more it has become a game of circumventing accounting conventions and IRS regulations. 

Inadvertently or not, the result has been to load balance sheets and income statements with hard to understand and analyze numbers, or worse yet, to take risks off the balance sheet entirely. In the process, too often the rising stock market valuations were interpreted as evidence of special wisdom or competence, justifying executive compensation packages way beyond any earlier norms and relationships. 

It was an environment in which incentives for business management to keep reported revenues and earnings growing to meet expectations were amplified. What is now clear, is that insidiously, almost subconsciously, too many companies yielded to the temptation to stretch accounting rules to achieve that result.

I state all that to emphasize the pressures placed on the auditors in their basic function of attesting to financial statements. Moreover, accounting firms themselves were caught up in the environment – - to generate revenues, to participate in the new economy, to stretch their range of services. More and more they saw their future in consulting, where, in the spirit of the time, they felt their partners could “better leverage” their talent and raise their income. 

I have a mental image of the role of an auditor. He’s a kind of umpire or referee, mandated to keep financial reporting within the established rules. Like all umpires, it’s not a popular or particularly well paid role relative to the stars of the game. The natural constituency, the investing public, like the fans at a ball park, is not consistently supportive when their individual interests are at stake. Matters of judgment are involved, and perfection in every decision can’t be expected. But when the “players”, with teams of lawyers and investment bankers, are in alliance to keep reported profits, and not so incidentally the value of fees and stock options on track, the pressures multiply. And if the auditing firm, the umpire, is itself conflicted, judgments almost inevitably

Continued at http://www.fei.org/download/Volker_Kellogg_Speech_6-25-02.pdf 

"We're The Front Line For Shareholders,"  by Phil Livingston (President of Financial Executives International), January/February 2002 --- http://www.fei.org/magazine/articles/1-2-2002_president.cfm 

At FEI's recent financial reporting conference in New York, Paul Volcker gave the keynote address and declared that the accounting and auditing profession were in a "state of crisis." Earlier that morning, over breakfast, he lamented the daily bombardment of financial reporting failures in the press.

I agree with his assessment. The causes and contributing factors are numerous, but one thing is clear: We as financial executives need to do better, be stronger and take the lead in restoring the credibility of financial reporting and preserving the capital markets.

If you didn't already know it and believe it deeply, recent cases prove the value of a financial management team that is ethical, credible and clear in its communications. A loss of confidence in that team can be a fatal blow, not just to the individuals, but to the company or institution that entrusts its assets to their stewardship. I think the FEI Code of Ethical Conduct says it best, and it is worth reprinting the opening section here. The full code (signed by all FEI members) can be found here.

. . .

So how did the profession reach the state Volcker describes as a crisis?

  • The market pressure for corporate performance has increased dramatically over the last 10 years. That pressure has produced better results for shareholders, but also a higher fatality rate as management teams pressed too hard at the margin.
  • The standard-setters floundered in the issue de jour quagmire, writing hugely complicated standards that were unintelligible and irrelevant to the bigger problems.
  • The SEC fiddled while the dot-com bubble burst. Deriding and undermining management teams and the auditors, the past administration made a joke of financial restatements.
  • We've had no vision for the future of financial reporting. Annual reports, 10Ks and 10Qs are obsolete. Bloomberg and Yahoo! Finance have replaced the horse-and-buggy vehicles with summary financial information linked to breaking news.
  • We've had no vision for the future of accounting. Today's mixed model is criticized one day for recognizing unrealized fair value contractual gains and alternatively for not recognizing the fair value of financial instruments.
  • The auditors dropped their required skeptical attitude and embraced business partnering philosophies. Adding value and justifying the audit fees became the mandate. Management teams and audit committees promoted this, too.
  • Audit committees have not kept up with the challenges of the assignment. True financial reporting experts are needed on these committees, not the general management expertise required by the stock exchange rules.

From the Chicago Tribune, February 19, 2002  --- http://www.smartpros.com/x33006.xml 

International Standards Needed, Volcker Says

WASHINGTON, Feb. 19, 2002 (Knight-Ridder / Tribune News Service) — Enron Corp.'s collapse was a symptom of a financial recklessness that spread during the 1990s economic boom as investors and corporate executives pursued profits at all costs, former Federal Reserve Chairman Paul Volcker told a Senate committee Thursday.

Volcker -- chairman of the new oversight panel created by Enron's auditor, the Andersen accounting firm, to examine its role in the financial disaster -- told the Senate Banking Committee he hoped the debacle would accelerate current efforts to achieve international accounting standards. Such standards could reassure investors around the world that publicly traded companies met certain standards regardless of where such companies were based, he said.

"In the midst of the great prosperity and boom of the 1990s, there has been a certain erosion of professional, managerial and ethical standards and safeguards," Volcker said.

"The pressure on management to meet market expectations, to keep earnings rising quarter by quarter or year by year, to measure success by one 'bottom line' has led, consciously or not, to compromises at the expense of the public interest in full, accurate and timely financial reporting," he added.

But the 74-year-old economist also blamed the new complexity of corporate finance for contributing the problem. "The fact is," Volcker said "the accounting profession has been hard-pressed to keep up with the growing complexity of business and finance, with its mind-bending complications of abstruse derivatives, seemingly endless varieties of securitizations and multiplying, off-balance-sheet entities. (Continued in the article.)

Title:  Final Accounting: Ambition, Greed and the Fall of Arthur Andersen 
Authors:  Barbara Ley Toffler, Jennifer Reingold
ISBN: 0767913825 
Format: Hardcover, 288pp Pub. 
Date: March 2003 
Publisher: Broadway Books

Book Review from http://www.amazon.com/exec/obidos/tg/stores/detail/-/books/0767913825/reviews/002-8190976-4846465#07679138253200 

Book Description A withering exposé of the unethical practices that triggered the indictment and collapse of the legendary accounting firm.

Arthur Andersen's conviction on obstruction of justice charges related to the Enron debacle spelled the abrupt end of the 88-year-old accounting firm. Until recently, the venerable firm had been regarded as the accounting profession's conscience. In Final Accounting, Barbara Ley Toffler, former Andersen partner-in-charge of Andersen's Ethics & Responsible Business Practices consulting services, reveals that the symptoms of Andersen's fatal disease were evident long before Enron. Drawing on her expertise as a social scientist and her experience as an Andersen insider, Toffler chronicles how a culture of arrogance and greed infected her company and led to enormous lapses in judgment among her peers. Final Accounting exposes the slow deterioration of values that led not only to Enron but also to the earlier financial scandals of other Andersen clients, including Sunbeam and Waste Management, and illustrates the practices that paved the way for the accounting fiascos at WorldCom and other major companies.

Chronicling the inner workings of Andersen at the height of its success, Toffler reveals "the making of an Android," the peculiar process of employee indoctrination into the Andersen culture; how Androids—both accountants and consultants--lived the mantra "keep the client happy"; and how internal infighting and "billing your brains out" rather than quality work became the all-important goals. Toffler was in a position to know when something was wrong. In her earlier role as ethics consultant, she worked with over 60 major companies and was an internationally renowned expert at spotting and correcting ethical lapses. Toffler traces the roots of Andersen's ethical missteps, and shows the gradual decay of a once-proud culture.

Uniquely qualified to discuss the personalities and principles behind one of the greatest shake-ups in United States history, Toffler delivers a chilling report with important ramifications for CEOs and individual investors alike.

From the Back Cover "The sad demise of the once proud and disciplined firm of Arthur Andersen is an object lesson in how 'infectious greed' and conflicts of interest can bring down the best. Final Accounting should be required reading in every business school, beginning with the dean and the faculty that set the tone and culture.” -Paul Volker, former Chairman of the Federal Reserve Board

“This exciting tale chronicles how greed and competitive frenzy destroyed Arthur Andersen--a firm long recognized for independence and integrity. It details a culture that, in the 1990s, led to unethical and anti-social behavior by executives of many of America's most respected companies. The lessons of this book are important for everyone, particularly for a new breed of corporate leaders anxious to restore public confidence.” -Arthur Levitt, Jr., former chairman of the Securities and Exchange Commission

“This may be the most important analysis coming out of the corporate disasters of 2001 and 2002. Barbara Toffler is trained to understand corporate ‘cultures’ and ‘business ethics’ (not an oxymoron). She clearly lays out how a high performance, manically driven and once most respected auditing firm was corrupted by the excesses of consulting and an arrogant culture. One can hope that the leaders of all professional service firms, and indeed all corporate leaders, will read and reflect on the meaning of this book.” -John H. Biggs, Former Chairman and Chief Executive Officer of TIAA CREF

“The book exposes the pervasive hypocrisy that drives many professional service firms to put profits above professionalism. Greed and hubris molded Arthur Andersen into a modern-day corporate junkie ... a monster whose self-destructive behavior resulted in its own demise." -Tom Rodenhauser, founder and president of Consulting Information Services, LLC

"An intriguing tale that adds another important dimension to the now pervasive national corporate governance conversation. -Charles M. Elson, Edgar S. Woolard, Jr., Professor of Corporate Governance, University of Delaware

“You could not ask for a better guide to the fall of Arthur Andersen than an expert on organizational behavior and business ethics who actually worked there. Sympathetic but resolutely objective, Toffler was enough of an insider to see what went on but enough of an outsider to keep her perspective clear. This is a tragic tale of epic proportions that shows that even institutions founded on integrity and transparency will lose everything unless they have internal controls that require everyone in the organization to work together, challenge unethical practices, and commit only to profitability that is sustainable over the long term. One way to begin is by reading this book. –Nell Minow, Editor, The Corporate Library

About the Author Formerly the Partner-in-Charge of Ethics and Responsible Business Practices consulting services for Arthur Andersen, BARBARA LEY TOFFLER was on the faculty of the Harvard Business School and now teaches at Columbia University's Business School. She is considered one of the nation's leading experts on management ethics, and has written extensively on the subject and has consulted to over sixty Fortune 500 companies. She lives in the New York area. Winner of a Deadline Club award for Best Business Reporting, JENNIFER REINGOLD has served as management editor at Business Week and senior writer at Fast Company. She writes for national publications such as The New York Times, Inc and Worth and co-authored the Business Week Guide to the Best Business Schools (McGraw-Hill, 1999).

Also see the review at  http://www.nytimes.com/2003/02/23/business/yourmoney/23VALU.html



Lessons Learned From SEC Chairman Harvey Pitt:  
The SEC is Still Under the Thumb of Corporate CEOs and Their Powerful Lobbyists

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.

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) carefully selected to inhibit major reforms and bright lines in the best interest of investors.  It was typical smoke and mirror politics in Washington DC there there seemingly was a glimmer of hope for reform that when push came to shove was dashed by powerful lobbyists.

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 





Lessons Learned About Why the Safeguards Failed?
Court Fines and Settlements Paid From an Accounting Firm's Petty Cash Do Not Improve Professionalism
In the early 1990s, the audit firms were on the brink of collapse due to litigation settlements that were being paid by large audit firms as the only solvent party to law suits --- the so-called "deep pockets" in class action suits.  Accounting lobbyists succeeded in engineering protection for joint and several settlements such that auditors became liable for only a portion of court settlements even if they were as much as 100% negligent in an audit.  The reasoning was that blame had to be apportioned to other culprits in the lawsuit even if the auditors should have prevented the damages to creditors and investors.  As a result the court settlements were often reduced to amounts that big firms could pay out of petty cash.  Andersen paid its share of the damages in the Waste Management scandal and was even allowed to carry on with the audit in subsequent years.  KPMG paid only $7 million in fines after being deemed by the SEC as contributing to a Medicare billing fraud by Columbia Medical that bilked taxpayers out of over $1 billion in theft.  Examples go on and on with respect to court settlements that hardly broke the stride of the auditing firms in the race for consulting and audit fees.  The public became so accustomed to such settlements, that reputation and integrity were no longer at stake in media publicity.


The Transformation of the Accounting Profession:
The History Behind the Big 5 Accounting Firms Diversifying into Law
by Colin Boyd, College of Commerce, University of Saskatchewan, 
Lower Quality Audits, Litigation, Insurance and Liability

Reducing the labour input to a given audit via reduced inspection, reduced supervision, or the use of cheap labour has obvious repercussions. Any reduction in the quality of the audit draws the danger of failure to observe some critical feature of the client’s operations, which can attract lawsuits for compensation by those affected by an auditor’s supposed negligence.

The late 80s and early 90s saw a plethora of financial scandals which drew attention to the role of the auditor in the detection of fraud. There was also an unprecedented wave of litigation against the big accounting firms. O’Malley (1993) considered that runaway litigation was threatening the survival of accounting firms of all sizes and had the power to destroy the accounting profession as a whole.

The profession itself had several explanations for the explosive growth of lawsuits against auditors.

First, there was a general propensity to increased litigation in society, with auditors being seen to have "deep pockets", able to be coerced into providing compensation to those affected by corporate failures.

Second, the US tort liability system was thought to be defective because it no longer provided reasonable compensation to victims by reasonable parties; the system's flaws were seen to be taking a severe toll on the accounting profession via unwarranted litigation and coerced settlements. (International Insurance Monitor, 1993)

Third, the profession considered that the public had unrealistic expectations regarding the auditor’s obligation and ability to minimize risk by preventing business fraud, mismanagement, error, and failure. (O’Malley, 1993) In the UK this so-called "expectations gap" had produced demands for improvements in the scope of auditing so as to conform to public expectations. (Cadbury Report 1992, p. 40; Humphrey et al. 1993)

Lee (1992) considered these explanations for the growth of lawsuits against the profession to be self-serving. He accused the Big Six of ignoring the very real presence of an audit crisis involving huge corporate failures and fraud. He suggested that increased legal activity in the industry was a natural consequence of an increase in audit failures.

As noted above, there were possible commercial reasons for reduced audit quality. The wave of litigation could be viewed as a delayed impact of evolutionary pressures on the workings of simple competitive dynamics: given a free, unregulated market for audits where price competition had developed, and given there was no regulatory mechanism to ensure some constant standard of production inputs, then it is not surprising that production inputs would be reduced and that quality would decline.

Whether justifiable or not, the legal actions against accountants proved to be expensive, both in terms of higher malpractice insurance payments, and in other direct costs:

"The Big Six say that malpractice-litigation costs, after insurance recoveries, rose to nearly 12% of total accounting and auditing revenue in 1993 from nearly 11% a year earlier. Such costs reached US$1 billion last year for the first time. " (Wise, 1994) One consequence of increased litigation was the possibility of accounting firms being driven out of business. Wooton and Tonge (1993) made the following prediction in the aftermath of the failure of a large US accounting firm: "The bankruptcy of Laventhol & Horwath may have been a unique event in accounting history, but its failure is more likely a prophecy of accounting-firm failures still to occur. As the accounting profession has grown more competitive, and as the industry faces more and more litigation, the probabilities of accounting firms failing have increased." (p. 158) One response by the accounting profession to this new environment of litigation was to seek to minimise liability where they had unlimited personal liability by virtue of the partnership form of organization of accounting firms. In the UK, various accounting firms threatened to move their head offices to the Channel Islands, where liability could limited in a different business law jurisdiction. As a result of these threats, the UK Government responded by modifying the relevant laws so as to introduce limited liability for public practice accountants.


Internal Watchdogs Must Be More Than Pet Rocks
The first line of defense when an audit client attempts to defraud investors or gets caught up gambling with an organization's resources far beyond the policy guidelines of risk taking, is the internal line of defense commencing with the employees, internal auditors, top management, audit committees, and the boards of directors.  Somewhere along the way, boards of directors and audit committees became pawns of top management.  Top management itself focused more on investments, mergers, and mega-deal making than tending to the store.  Top management also focused on putting the "right" people into place on audit committees and boards of directors.  These were usually people who at best were wimps who saluted the CEO and at worst were knowingly part of the con games.  Recent revelations from Tyco reveal how a board member and a CEO could conspire to bilk investors out of millions and millions of dollars.  The Board of Directors at General Electric agreed to give Jack Welch millions upon millions in perks even after he retired, including lifetime use of corporate jets for pleasure trips and toothpaste and other toiletries.

The most successful watchdogs have been the low end of the feeding chain --- those lower paid clerks and accountants who eventually work grow so sick of the phony accounting taking place that they finally work up enough nerve to blow the whistle.  But by then, as in the case of Enron, their revelations are usually diverted or stonewalled until it becomes too late to protect investors.  For example, when Sherron Watkins blew the whistle on accounting so bad that it could bring down Enron, top management in both Enron and Andersen ran to their lawyers rather than face up to the bad situation and try to do everything possible to correct the bad accounting.

External Auditors Must Be Willing to Lose Clients in Efforts to Maintain Reputation and Professionalism
Auditors at best were merely lost in the complexities of the deal making and at worst they knowingly became part of conspiracies.  Professionalism of service gave way to risk analysis in terms of probabilities of getting caught for bad work and the cost (fines and litigation) versus the bottom line profits.  As consulting opportunities increased, auditors commenced to lose sight of the fundamentals of independence.  The profits were no longer in auditing.  Career success shifted to consultancy in place of the drudgery of substantive testing.  The audit business model itself was not conducive to placing high priced and experienced talent where it was desperately need in audits.  Firms instead placed new college graduates on assignments where they had neither the skills nor the experience to do competent work.  Network computers became complex vehicles in which the auditors only kicked on the tires to check on the internal controls and operating effectiveness.

The SEC Has Never Been and Will Never be Free and Independent of Rich and Powerful Lobbyists
Like virtually all regulatory agencies in Washington, the rich and powerful organizations being regulated manage to use wealth and political influence to control the agencies designed to regulate those rich and powerful organizations.  Agribusiness controls the FDA.  Power companies control the FPC.  Telecommunication giants control the FCC.  What agency gets tough prior to a media scandal that sets elected officials scurrying to put on a show of investigating the failures of the regulating agencies?

The bottom line is that government agencies cannot be relied upon to continuously play fair with the public when they are inside the jaws of the corporations they regulate.

The FASB Continues to be Micro-managed and Bogged Down in Due Process
Although FAS 133 on Accounting for Derivative Financial Instruments and Hedging Activities is the supreme example of FASB encumbered a rather simple goal with 538 paragraphs of technical jargon that virtually nobody understands, there are other FASB standards that are nearly as confusing, inconsistent, and ineffective as FAS 133.  The problem begins with due process in which a simple concept like booking derivatives at fair value and recording changes in that value as earnings gets encumbered with favors to companies to a point where earnings changes are buried on convoluted burial grounds such as the "Other Comprehensive Income" cemetery for cash flow hedges or the "firm commitment" offset for fair value hedges.  In the process, the FASB lost sight of the big picture that allowed Enron to bilk investors with bad accounting rules for "Special Purpose Entities."  In short, the FASB fiddled while investors burned.

Hartgraves and Benston state the following:

After more than 20 years since SPEs appeared on the scene, there remains a confusing, if not convoluted, set of guidelines regarding the consolidation of SPEs.
A.L. Hargraves and G.L. Benston, "The Evolving Accounting Standards for Special Purpose Entities and Consolidations," Accounting Horizons, September 2002, Page 245.

The Public Has Grown Numb to Tabloid Exposures
Enormous tabloid exposures like President Clinton's sexcapades and repeated exposes of audit failures have numbed the world to a point where guilty parties continue on the road to fortune in spite of tarnished images.  For example, most everybody except for Representative John Dingle merely yawned at the media revelations of violations of SEC independence rules for auditors.


January 6, 2000

The Honorable Arthur Levitt, Jr.
Securities and Exchange Commission
450 Fifth Street, NW
Washington, D.C. 20549

Dear Chairman Levitt:

    Thank you for transmitting a copy of the SEC news release on the independent consultant report finding numerous significant violations of the firm’s, the profession’s, and the SEC’s auditor independence rules by PricewaterhouseCoopers and its partners and other professionals.

    I have raised these concerns to the SEC and held Oversight and Investigations Subcommittee hearings about accountant/auditor independence issues in the past. The General Accounting Office’s two-volume 1996 report, The Accounting Profession (GAO/AIMD-96-98), expressed GAO’s belief that "the SEC should take a leadership position in working with the accounting profession to enhance the auditor’s independence." At that time, the SEC Chief Accountant agreed with the auditor independence concerns identified in the GAO report and also agreed that they "must be resolved." (See September 5, 1996 letter from Michael H. Sutton, Chief Accountant, SEC, to Charles A. Bowsher, Comptroller General of the United States.) SEC delegated that responsibility to a newly-formed Independence Standards Board (ISB) in 1997. From what I have observed, the ISB has done little more than hold inconclusive "standard setting meetings" since that time, while the conflicts of interest have multiplied and the problem has progressively worsened.

    Moreover, common sense tells us that the problems revealed in the PwC report are not confined to that firm. The accounting profession is now the management services industry: the profession and the companies that it is charged with auditing to protect investors and the integrity of our markets are quickly becoming wholly-owned subsidiaries of one another. Self-interest has replaced much of the profession’s fidelity to the public trust.

    The federal securities laws require that financial statements filed with the SEC be certified by independent public accountants. The U.S. Supreme Court has stated that "[t]he independent public accountant ... owes ultimate allegiance to the corporation’s creditors and stockholders, as well as to the investing public. The ‘public watchdog’ function demands that the accountant maintain total independence from the client at all times and requires complete fidelity to the public trust...." U.S. v. Arthur Young & Co., 465 U.S. 805, 817-818 (1984).

    I want to know what the Commission and the ISB, having taken little meaningful action to date, are doing to clean up this mess. I look forward to your response.





Lessons Learned From the History of Capitalism
There is a history of monumental scandals in securities markets including the Dutch tulip mania in the 17th Century, England's South Seas bubble in the 18th Century, America's stock market and Florida real estate scandals of the 1920s, Japan's stock and land market exposes in the 1980s, and the derivatives security scandals near the end of the 20th Century (e.g., Barings Bank, Orange County, and Long Term Capital fiascos.)  These were all scandals of monumental proportions, because in each case the public lost confidence in equity capital to a point where the future of capitalism teetered at the brink.  But in each case, a few publicized punishments of the scoundrels and some accounting and legal reforms lured investor money back into equity capital markets.

Capitalism is probably less threatened today by enormous financial scandals, because individual investors have lost a great deal of power and influence.  Their fortunes are tied up in enormous pension and savings funds that are controlled by a much smaller set of managers and insiders who are less likely to panic and bring down the entire system.  I'm not arguing that the shift in power from millions of individual investors to hundreds of fund managers is necessarily a good thing in general.  However, in the case of enormous financial scandals and plunging stock prices, the large funds held in trust serve as a buffer to panic.  Nor am I claiming that fund managers are not upset over abuses of privilege and power by corporate executives and truly dirty and rotten investment bankers.  In the present crisis, we are seeing some of those powerful fund managers bringing a great deal of pressure upon companies to clean up their accounting systems and their governing boards.

The one thing to be learned from history is that integrity and efficiency of capital markets, like prices themselves, are subject to upward and downward movements along trend lines.  There will be swings upward in integrity followed by drops leading to future scandals and media feeding on the carcasses of dead corporations and accounting firms.

Capitalism would probably never rise again if some alternative economic system ever moved in to bring more prosperity in its wake.  Unfortunately, virtually all the alternatives pale in terms of the progress the Western world has made in eliminating despair, ignorance, poverty, and lethargy among people fortunate enough to live in an economy where the laws of capitalism are enforced.

The two major ingredients of recovery of capital markets at the present time are as follows based upon a long history of corporate and accounting scandals:

  1. It is imperative for lawmakers to convince the public that securities laws will be enforced (even if this is not always the case, enforcement should be the rule rather than the exception.)

  2. Genuine progress toward a return to fairness and ethics is imperative for accountants, securities dealers, bankers, investment bankers, and other professionals whose reputations have been dragged through the mud.  Reforms must be effective, and the tone at the top in these professions must be real in contrast to mere lip service and hollow promises.



Concluding Remarks
The public is probably expecting too much from hopes raised and promises made by corporate, government, and accounting firm leaders.  There will be a marked return to professionalism among auditors, but systemic problems in auditing cannot be overcome by pep talks and greater ethics.  For example, the fact remains that networked computing and other complex technologies have created problems which auditors cannot solve in the next ten years and may never solve to a point where auditing keeps pace with newer technologies.  In the 1980s, audit trails began to stumble over computing boxes that obscured trails and created information insecurity, fragility, and auditing problems that have grown exponentially with technology.  See http://www.trinity.edu/rjensen/FraudConclusion.htm 

Opportunities for deceiving auditors are no less today than before Enron imploded and Andersen exploded.  Opportunities for off-balance sheet financing are no less today than two years ago.  Opportunities for managing earnings and inflating reported revenues still abound.  We are no better at reporting intangible assets and liabilities today than we were ten years ago.  As we speak, accountants and lawyers are busy inventing new contracts to circumvent the new rules created because of Enron.   See http://www.trinity.edu/rjensen/FraudConclusion.htm


The new independence rules probably create more problems than they solve.  Increasingly, auditing will be done by machines that audit machines --- the so called auditbots that audit the transactions bots.  The hope was once that consulting and systems opportunities would maintain the attractiveness of accountancy as a profession.  Accountancy must find alternatives other than auditing or it will steadily decrease in attractiveness as a career.  

Career Passed Away --- An Excerpt from http://www.trinity.edu/rjensen/cpaaway.htm 
June 4, 2025

Dr. Robert E. Jensen
Department of Business Administration
Trinity University
715 Stadium Drive
San Antonio, TX  78212

Dear Professor Jensen:

It has been a long time since we last communicated.  Since the demise of the CPA examination, we have not hired a CPA.  It is my understanding that accounting majors are now part of your Computer Science Department.  However, legacy SEC rules require that public accounting firms have at least one old-style CPA, and therein lies our problem.  We need to make contact with former students having old-style CPA credentials.  None of the accounting graduates in the past decade could become CPAs.  What also makes it difficult is our firm's policy requiring that applicants have a graduate degree in penmanship.  If you can think of any qualified applicants, please forward their names to us.

Each of the Big 3 public accounting firms has one CPA.  He's called the Signer.  On the occasion of his 100th birthday on June 14, our Signer named Ebenezer Overhill will retire.  Since he only gets $5 for each signed audit report, he could not afford to retire until this year.  Mr. Overhill takes great pride in his signature and can only manage two per hour.  We are very proud of our Mr. Overhill.  Last year the entire membership of the AICPA met in a restaurant to honor him.  He received the AICPA Lifetime Signer Award.  Our firm strives to carry on the signature TQM that is a tradition due to our wonderful Mr. Overhill.

You may wonder who conducts the audits and generates the reports that the SEC requires Mr. Overhill to sign.  Our auditor's name is HAL EVERY.  HAL's a massive parallel processor capable of tracking every transaction of every worldwide client during every hour of every day.  Ironically, our prospering Consulting Division was sold in Year 2000 due to SEC concerns about audit independence.  Now we outsource all HAL design and operation duties to our former Consulting Division.  But the SEC requires that our CPA sign each and every audit report.  Mr. Overhill does not have clue about HAL.  Just between us, he can't even remember HAL's name.  But nobody in public accounting has a finer signature than our Mr. Overhill.

I do miss the days when our home office was on the top floor of a New York skyscraper.  Leasing such luxurious space is no longer necessary since Mr. Overhill and I are the only employees of the firm.  Mr. Overhill used to dictate all the letters that I typed.  Alas, a stroke on July 7, 2016 made his speech incoherent.  But he will sign this letter.  He still likes to sign all correspondence going out of this office.  Thus far this year, there were five letters typed and mailed the old fashioned way.  We have not had to worry about client correspondence since the 2014 SEC ruling that all domestic and international clients  must be randomly assigned to the Big 3 firms.  Our clients communicate directly with HAL.  We do see their names on the tops of the audit reports that must be signed.

There's plenty of room in Mr. Overhill's garage for our office since his old car was sold.  The State of New York refused to renew his driving license after he became blind.  But at his advanced age, it is nice that his desk is only 12 feet from the bedroom door and 23 feet from the commode.  With help, he can make it more than half the time without wetting himself.  And I only have to run over here from my house next door. 

Even though Mr. Overhill will sign this letter, please remember that my name is Barbara Pawalski if you telephone our office.  Please address all mail to Mr. Overhill.  I read every letter aloud  to him, although there have been no letters in the past two years.  He would so enjoy getting a letter. I regularly read parts of HAL's audit reports to Mr. Overhill until he dozes off.

Very truly yours,

Ebenezer Overhill, CPA

Continued at http://www.trinity.edu/rjensen/cpaaway.htm  



My conclusion is that we have not learned much overcoming systemic problems in accounting and auditing in the wake of the Enron scandal.  The exploding of Andersen almost overnight did, however,  shake our top CPA leaders who are now bent on restoring confidence in auditors and their attestation professionalism.  Mostly good will come from this, but changes must be more than hype.  Restored confidence will sink even lower in each succeeding wave of scandals and deceptions.

We have added layers of oversight for auditors, but virtually nothing has been done to thwart white-collar crime at its source.  In general, financial statement audits are not performed to detect or thwart white-collar crime.  Going after the auditors is only a very small step against white-collar crime.  The following would be more effective:

  • Eliminate cash liquidity in the world economy.  All flows of money should be traced much like debit and credit card settlements can be traced today.  Until money laundering is eliminated, crime trails will always be easy to conceal.

  •  Focus more on cleaning up the professions of security analysis and investment banking.  Most of the legislation has focused on the auditors rather than the source of most of the recent scandals in an industry that is rotten to the core.  See http://www.trinity.edu/rjensen/fraud.htm#Cleland 

  • Make it far more difficult to siphon money with the help and power of U.S. Representatives, Senators, and Executive Branch officers.  This was a ploy used repeatedly by Enron in deregulating energy pricing and in trying to use political influence in tying cooperation with U.S. business firms to U.S. AID payments.  Thus far, I've seen no legislation to stop that from happening repeatedly in future years.  

by Russell Mokhiber and Andrew Wheat 
The deal, in which Enron beat out South Africa's state petroleum company Sasol, sparked controversy in Africa following reports that the Clinton administration, including the U.S. Agency for International Development, the U.S. Embassy and even National Security adviser Anthony Lake, lobbied Mozambique on behalf of Enron.

"There were outright threats to withhold development funds if we didn't sign, and sign soon," John Kachamila, Mozambique's natural resources minister, told the Houston Chronicle. Enron spokesperson Diane Bazelides declined to comment on the these allegations, but said that the U.S. government had been "helpful as it always is with American companies." Spokesperson Carol Hensley declined to respond to a hypothetical question about whether or not Enron would approve of U.S. government threats to cut off aid to a developing nation if the country did not sign an Enron deal.

Enron has been repeatedly criticized for relying on political clout rather than low bids to win contracts. Political heavyweights that Enron has engaged on its behalf include former U.S. Secretary of State James Baker, former U.S. Commerce Secretary Robert Mosbacher and retired General Thomas Kelly, U.S. chief of operations in the 1990 Gulf War. Enron's Board includes former Commodities Futures Trading Commission Chair Wendy Gramm (wife of presidential hopeful Senator Phil Gramm, R-Texas), former U.S. Deputy Treasury Secretary Charles Walker and John Wakeham, leader of the House of Lords and former U.K. Energy Secretary.

  • Pass serious legislation to promote and reward whistle blowing.  There has been no such legislation in the past year.  

  • Take the country club atmosphere out of Federal prisons.  Make convicted white collar crime serve unpleasant lock ups for durations proportionate with the amount of damage caused and do no let the culprits like Mike Milken return to a life of luxury after the sentences are served.

  • Make it virtually impossible to flee to places like Switzerland and thumb a nose at U.S. law enforcement.  This is essentially what convicted felon Mark Rich did before buying a pardon from former U.S. President Bill Clinton who pardoned Rich in the dark of night while moving out of the White House.  See http://brian.carnell.com/articles/2001/02/000040.html 

    The tone at the top determines the melody!  Stop CEO Rents!
Feeling cynical?

 If you aren’t now, you will by the time you finish the new Bebchuk and Fried paper on executive compensation.  They paint a fairly gloomy picture of managers exerting their power to “extract rents and to camouflage the extent of their rent extraction.”  Rather than designed to solve agency cost problems, the paper makes the case that executive pay can by an agency cost in and of itself.  Let’s hope things aren’t this bad. 

They say that patriotism is the last refuge
To which a scoundrel clings.
Steal a little and they throw you in jail,
Steal a lot and they make you king.
There's only one step down from here, baby,
It's called the land of permanent bliss.
What's a sweetheart like you doin' in a dump like this?

Lyrics of a Bob Dylan song forwarded by Damian Gadal [DGADAL@CI.SANTA-BARBARA.CA.US




My key documents on these matters are at the following sites:

Bob Jensen's threads on the Enron/Andersen scandals are at  http://www.trinity.edu/rjensen/fraud.htm  
Bob Jensen's SPE threads are at http://www.trinity.edu/rjensen//theory/00overview/speOverview.htm  
Bob Jensen's threads on accounting theory are at http://www.trinity.edu/rjensen/theory.htm  

Bob Jensen's Summary of Suggested Reforms --- http://www.trinity.edu/rjensen/FraudProposedReforms.htm 

Bob Jensen's Bottom Line Commentary --- http://www.trinity.edu/rjensen/FraudConclusion.htm 

The Virginia Tech Overview:  What Can We Learn From Enron? --- Click here.

Bob Jensen's Homepage --- http://www.trinity.edu/rjensen/

In response to a message from David Albrecht on September 24, 2002

Hi David,

I hope you do not mind if I send this to the AECM. There may be some others like you who would like to hear Art Wyatt talk about Andersen and Enron. I am actually more interested in hearing Art than in speaking myself, although you can see my continuously revised draft at http://www.trinity.edu/rjensen/fraudVirginia.htm

You asked when I will be in Virginia. I am actually arriving at the Hotel Roanoke on September 28 to save $800 in air fare. Without a Saturday night stay over, the air fare to Roanoke was a killer. Even though I am being reimbursed, I did not want to make the Virginia Society pay an added $800. Art and I speak on September 30, and then I depart for Indian Rocks Beach (near Clearwater in Florida) where I am doing an education technology workshop for the FAAE.

Art and I will be doing the same Enron/Andersen thing at the Hotel Roanoke on November 21. The hotel's address and phone numbers are shown below:

110 Shenandoah Avenue,
Roanoke, VA 24016
Phone: 540-985-5900 Fax: 540-853-8290 1-800-222-TREE

Below you will see a message from Sam Hicks from Virginia Tech. Sam provides some added information and a Web link.

Special note to Sam: I can't recall if I sent an outline. If not, please go to http://www.trinity.edu/rjensen/fraudVirginia.htm


Bob Jensen

-----Original Message-----
From: shicks@vt.edu [mailto:shicks@vt.edu
Sent: Monday, August 05, 2002 12:16 PM
Subject: Virginia Accounting and Auditing Conference

Thank you for agreeing to speak at the 2002 A&A Conference. The advertising copy is in the mail and is posted on the VSCPA web site at


The conference will be a success only because of you and your preparation for your presentation. I know it is a lot of work and for little reward. But it is a great service to the CPAs of Virginia and they and we certainly appreciate your efforts.

We need the outline from you as soon as possible. We must take the outlines to the printer on September 4. In order for us to get the semester started and do the work we need to do to put your outline in the notebook, we need your Word or PowerPoint or other file, by August 30 at the absolute latest.

Thank you for your willingness to speak. I look forward to receiving your outline and hearing your talk. On the behalf of the conference program committee, thank you for your support of the conference.

PS, if you have already sent your outline, thank you.

Have a good day!

Sam A. Hicks
Department of Accounting and Information Systems
Mail Code 0101, 3011
Pamplin Hall
Virginia Tech,
Blacksburg, VA 24061
Phone 540-231-6577

From The Wall Street Journal Accounting Educators' Review on September 27, 2002

TITLE: Accounting Firms Are Still Consulting
REPORTER: Cassell Bryan-Low
DATE: Sep 23, 2002
LINK: http://online.wsj.com/article/0,,SB1032736856302232033.djm,00.html 
TOPICS: Auditing, Auditing Services, Auditor Independence, Consulting, Audit Quality

SUMMARY: Even though recent legislation restricts the consulting work that auditors can perform for their clients, approximately fifty-percent of total revenue in the Big Four accounting firms is from non-audit services. Questions focus on the advantages and disadvantages of providing non-audit services to audit clients.


1.) Why do auditors need to maintain independence? Does performing non-audit services for audit clients compromise independence? Support your answer.

2.) What type of non-audit services can auditors perform for their audit clients? What non-audit services are prohibited under the new legislation? What is the underlying logic of prohibiting certain non-audit services while allowing other non-audit services?

3.) Discuss the comment made by former Securities and Exchange Commission Chairman Arthur Levitt concerning the industry serving public interest and the possible need for stronger legislation. Do you agree with Mr. Levitt?

4.) Discuss the advantages and disadvantages of accounting firms offering a wide range of services. Discuss the advantages and disadvantages of accounting firms limiting services to audit, tax and closely-related services.

Reviewed By: Judy Beckman, University of Rhode Island
Reviewed By: Benson Wier, Virginia Commonwealth University
Reviewed By: Kimberly Dunn, Florida Atlantic University

"Even Without Consulting Arms, Accounting Firms Still Consult," by Cassell Bryan-Low, The Wall Street Journal, September 23, 2002, PAGEC1 --- http://online.wsj.com/article/0,,SB1032736856302232033.djm,00.html

The new federal legislation prevents accounting firms from providing various services to their publicly traded audit clients. Among these: information-system design, internal auditing, bookkeeping, appraisal and valuation work, actuarial services, investment banking, legal work and management tasks. When such often-lucrative contracts are in place, the thinking goes, auditors may be less likely to challenge their clients on accounting issues for fear of jeopardizing this other business. In the case of internal auditing, an extra concern is that auditors could end up auditing their own firm's work. (In the case of Enron, Andersen earned $25 million in auditing fees in 2000 and $27 million for other work.)


"Firms are going to have to assess their current range of service offerings and decide which ones will continue to be viable economically for them," says J. Michael Cook, retired chief executive of Deloitte & Touche LLP. They need to ask: "Do we want to be Howard Johnsons and offer 28 flavors, or are we better served in offering only chocolate, vanilla and strawberry: audit, tax and closely-related services?"

Almost three-quarters of fees paid to accountants by audit clients in 2001 were for nonauditing services, according to an analysis of regulatory filings by 21 of the Dow Jones Industrial Average's 30 companies. Overall, audit fees will account for closer to half of all revenue this year, once all of the firms have spun off their large consulting units, industry experts say.

Accounting firms are quick to note that they can continue to provide the various services, just not to their audit clients. However, there is one drawback: In relying on nonaudit clients, the firms no longer can draw on audit relationships to line up contracts.

"Obviously, we're looking at the provisions of the law and will do what we need to do," says Deborah Harrington, a Deloitte spokeswoman, echoing sentiments at fellow Big Four members Ernst & Young LLP, KPMG LLP and PricewaterhouseCoopers LLP.

One element of the legislation giving accountants pause is the restriction on sales to their public audit clients of "expert services related to the audit." Auditors fear a broad interpretation could impinge on lucrative tax-consulting work. How regulators interpret that could affect what the firms spin off.

Even before the legislation, market forces were at work to the same end. PricewaterhouseCoopers, the nation's largest audit firm, recently sold its bankruptcy-and-litigation-related services business, which had $170 million in revenue for the fiscal year ended June 30, to boutique firm FTI Consulting Inc. It sold a division dealing with valuations for mergers and other transactions to McGraw-Hill Cos.' Standard & Poor's Corp., and it also sold a lobbying practice and most of a broker-dealer business. Partners earlier this month approved the sale of the information-technology consulting unit for $3.5 billion in cash and stock to International Business Machines Corp., a pact expected to close early next month and ending a roughly two-year divestiture effort.

Samuel DiPiazza, the accounting firm's chief executive, disputes that such services create a conflict of interest, but says, "the perception is such that it makes it harder to operate."

Another pressure for divestitures: resistance accountants can face from their own audit clients in offering services to other firms. For example, a bank may not be thrilled for its auditor to represent a distressed company against which it has claims.

Eugene O'Kelly, KPMG's CEO, says legal services that the firm provides overseas to U.S. registrants are "under strategic review." He added that the U.S. firm in recent years had scaled back other services restricted by the recent legislation. Mr. O'Kelly says his firm had lost some internal-audit-outsourcing clients as a result of the legislation but has in turn picked up others from rivals.

Beth Brooke, Ernst & Young's global vice chairman for strategy, says: "As a general business matter, we are always evaluating the level of services we provide." She adds that the legislation is affecting how business is being conducted, more than how much business is being done. At the firm's global partner meeting in Orlando, Fla., Sunday, senior executives -- including Ms. Brooke -- made presentations on strategy going forward emphasizing both retention of current audit partners and ways to develop other business relationships with nonaudit clients. Ernst & Young and KPMG shed their large consulting divisions in 2000 and 2001, respectively.

The last big firm to announce it would divest itself of its information-technology consulting business was Deloitte. In February, it said it was reluctantly doing so to allow audit clients to continue to use Deloitte Consulting without raising concerns about auditor independence. Deloitte plans to separate the unit by year's end as a privately owned partnership, to be called Braxton, in which Deloitte intends to retain a minority interest of as much as 20%, subject to regulatory approval.

Corrections & Amplifications:

Pricewaterhouse Coopers LLP recently sold its U.S. bankruptcy business to FTI Consulting Inc. The above article incorrectly stated that the division also provided litigation-related services, which PricewaterhouseCoopers continues to provide.

Continued at http://online.wsj.com/article/0,,SB1032736856302232033.djm,00.html

Hi David,

Your comments are VERY HELPFUL. Would you mind if I include them in my next edition of New Bookmarks? See http://www.trinity.edu/rjensen/bookurl.htm 


Bob Jensen

Original Message----- 
From: David Storhaug [mailto:storhaug@btinet.net]  
Sent: Wednesday, September 25, 2002 1:36 AM 
To: Jensen, Robert Subject: What Can We Learn From Enron?

Hi David,

Your comments are VERY HELPFUL. Would you mind if I include them in my next edition of New Bookmarks? See http://www.trinity.edu/rjensen/bookurl.htm 


Bob Jensen

Original Message----- 
From: David Storhaug [mailto:storhaug@btinet.net]  
Sent: Wednesday, September 25, 2002 1:36 AM 
To: Jensen, Robert Subject: What Can We Learn From Enron?

Dr. Jensen:

This evening I found time to catch up on my professional digests received by e-mail (including CPAS-L),  and noted that you had invited comments to your planned presentations for 9/30/2002.   By coincidence,  earlier today I attended a seminar  "Is there a Crisis in Financial Reporting?"  put on by George Letcher and Ray Thompson,   accounting professors from Univ Pittsburgh - Johnstown.

Not surprisingly,  there is some overlap in your separate presentations and there are some differences. They based their presentation on 10 major problems needing to be addressed to improve the financial reporting process,   as taken from a joint position paper  (JWSP) prepared by the Big 5 and AICPA..    Their lead in was an overview of what went wrong with Enron,  buttressed by extra details on Enron woven into each of the 10 points.

They addressed the same points as included in your presentation's reference to the following quote by Mr. Volker.
Moreover, accounting firms themselves were caught up in the environment – - to generate revenues, to participate in the new economy, to stretch their range of services. More and more they saw their future in consulting, where, in the spirit of the time, they felt their partners could “better leverage” their talent and raise their income.

I.e. Over the years there has been a tendency for CPA's,   (particularly some key players at Arthur Andersen)  to gradually evolve from being professionals (with skepticism and remembering their duty to serve third parties) to being merely sales people whose primary drive was to please only the client at all costs.

My personal observation is that the removal of the prohibition against soliciting only aided and abetted the above,  yet I seldom hear that mentioned.  

My recollection and summary of the 10 points presented by George Letcher and Ray Thompson were:

1 Pressure to perform:   culture at SEC listed companies to meet and beat quarterly earnings expectations at all costs.

2.  Complexity:  Ever increasing array of complex financial arrangements and structured transactions being created by investment bankers,  financial engineers and CPA's.   Ken Lay hired Arthur Anderson because the prior CPA firm wasn't "creative enough".

3.  Standards overload:   recent history of FASB, AcSEC, and SEC  had been "abuse driven" rather than principles based.   Abuses lead to complex standards which only invite a response of trying to find yet another loop hole.

4.  Internal control and down sizing:   A common fact of life in current American corporate landscape,   but often with negative effects on internal control and segregation of duties,   along with overwhelming workload and insufficient time to complete tasks.    The structure was not in place to properly handle Watkin's attempts to call attention to the problems.

5.  Related parties:  most every corporation has some related party transactions,   but Enron had over 3000.    This is a fact which should have raised flags by itself.

6.  Off balance sheet items and special purpose entities.   They went though the history of the 3% rule and illustrated how this rule (originally from leasing) was perhaps distorted to for its use in Enron's SPE's.    However an additional factor was the "undisclosed" but improper ownership of even the 3%.

7.  Materiality:   They went through the mechanics of how Enron / AA reached their distorted conclusion that $51 million was not material,   primarily by the use of "normalized accounting",  a concept that is sometimes used in determining materiality when auditing companies which are very new and have no prior track record;  so it is sometimes proper to determine a materiality level based on income derived (imputed) from other companies in a similar business.   It was questionable to use this concept with Enron since it was not a new company.
8.  Pro forma earnings:  

9.  Audit committees:   They went through the makeup of Enron's audit committee,   pointing out the remoteness of many,   and pointing out how one educator might have had  his independence called into question because of the large donations Enron made to his University.

10.  Consulting services and independence.   They went through the history of Arthur Levitt's attempts to rein in this,  and how the AICPA and Big 5 beat him back,   and how this helped create the backlash of the recent PCRA enacted into law.

The above was all very interesting,   but not always directly applicable to my practice as a local practitioner with non-public clients.   I was looking for talking points for potential use with legislators in an anticipated need to react to the expected "cascade effect" from SEC practice down to the small business practice.   It wasn't the main topic of discussion,  but in talking to various participants, and also visiting with Mr. Letcher and Mr. Thompson,   I came up with the following 
distinctions between SEC level clients and practice and NON-SEC clients and practice:

1.   Unity of ownership and management's for most NON-SEC clients,   compared to the separation of ownership and management with SEC companies.   Specifically,   the ownership of SEC companies tends to be "uninformed".

2.   Absence of the quarterly drive to meet earnings expectations with NON-SEC clients.

3.    Non SEC companies are more apt to have a close,  perhaps even personal relationship with their banker (who often exercises restraint over the client).   By contrast,  SEC clients most often issue bonds to an impersonal market.

4.    Lesser,  perhaps no need for restrictions on consultation with NON-SEC clients,  since the smaller companies will be hurt,  not helped, by restrictions on consulting.  Smaller companies usually don't have the luxury of being able to afford two sets of professionals (auditors and consultants) and the cost of getting these two sets familiar with their business.   Instead they need the efficiency gained by leveraging the auditor's familiarity with the business by allowing him to also be a consultant (in most cases).

5.   Smaller NON-SEC companies are more heavily influenced by the urge to save  income tax.    While they have some of the same aspect of trying to beat earnings expectations (because it will help them maintain good relations with their banker) a countervailing force is their strong urge to hold down income tax.

The above 5 points are not directly related to your invitation for comments,   but I found the analysis helps to put the both the SEC and non-SEC situations into better perspective.

Dave Storhaug, CPA 
Bismarck ND