Introductory Quotations 

If the Big Four shrinks to the Big Three, some clients will continuously employ all three firms.  Accounting Firm 1 hired for audits is not allowed to perform tax services or information system consulting.  Accounting Firm 2 hired for tax services runs a liability risk if it also designs the information system feeding the tax information.  Accounting Firm 3 hired for information systems consulting is not allowed to perform audits and probably should not perform tax services. 

It will be very confusing unless something is done to distinguish the external accountants in the client's offices. I suggest color codes.

What will the colors be,
after there are but three?

I wonder if the Big Three will adopt distinct colors.  As I recall Andersen employees preferred orange shirts when demonstrating outside the Justice Department (in a pouring rain) around the time Andersen was being tried for obstruction of justice in the destruction of Enron’s audit files.  White has been pretty well taken up by medical services.  Black has always been the most popular auditor color --- when I worked for Ernst, I was required to have a black fedora to match my black suits.  But undertakers also prefer black.  Traders in the commodity pits wear bright colors.  Why can’t accountants do the same?

Seriously, I always thought Andersen's choice of orange was rather ironic. This is too close to prison-orange for a firm that is trying to fend off a criminal conviction.

Quotations

At a time when U.S. firms are more reliant than ever on quality accounting and auditing services, the influential Business Roundtable is supporting liability caps for auditors. The Roundtable is worried that the Big Four accounting firms could soon shrink to three or fewer firms if Congress doesn't act to stem the liabilities the firms face when things go wrong. 
"Business Roundtable Supports Auditor Liability Cap," AccountingWeb, January 18, 2005 --- http://www.accountingweb.com/item/100390 

Discontent is rightfully rising over CEO pay versus performance
In fact, the boss enjoyed a hefty raise last year. The chief executives at 179 large companies that had filed proxies by last Tuesday - and had not changed leaders since last year - were paid about $9.84 million, on average, up 12 percent from 2003, according to Pearl Meyer & Partners, the compensation consultants. Surely, chief executives must have done something spectacular to justify all that, right? Well, that's not so clear. The link between rising pay and performance remained muddy - at best. Profits and stock prices are up, but at many companies they seem to reflect an improving economy rather than managerial expertise. Regardless, the better numbers set off sizable incentive payouts for bosses. With investors still smarting from the bursting of the tech bubble, the swift rebound in executive pay is touching some nerves. "The disconnect between pay and performance keeps getting worse," said Christianna Wood, senior investment officer for global equity at Calpers, the California pension fund. "Investors were really mad when pay did not come down during the three-year bear market, and we are not happy now, when companies reward executives when the stock goes up $2."
Claudia H. Deutsch, "My Big Fat C.E.O. Paycheck," The New York Times, April 3, 2005 --- http://www.nytimes.com/2005/04/03/business/yourmoney/03pay.html?
Bob Jensen's threads on corporate fraud are at http://www.trinity.edu/rjensen/fraud.htm
Bob Jensen's updates on fraud are at http://www.trinity.edu/rjensen/fraudUpdates.htm

Steve Albrecht (former American Accounting Association President and Professor of Accounting at Brigham Young University) conducted interviews when Barry Minkow was still in prison.  You can read Steve's account of the ZZZZ Best Fraud at http://www.swcollege.com/vircomm/stice_survey/sts/sts04.html 

Question
Why is there so much investment fraud?

Answer
What we have is a perfect fraud storm. In places across the country with an appreciating housing market, low interest rates, and consumers dissatisfied with Wall Street returns, you'll find people ripe for [perpetrators].
"Ten Questions for Barry Minkow," CFO Staff, by CFO Magazine, January 2005, Page 20 --- http://www.cfo.com/article.cfm/3516399/c_3516777?f=magazine_alsoinside 

The current head of the Fraud Discovery Institute, Barry Minkow, also served more than seven years in prison for the infamous ZZZZ Best scam.

Barry Minkow says he plans to be remembered for more than the ZZZZ Best Co. fraud. The 38-year-old Minkow served more than seven years in prison for the infamous 1980s scam. But he hopes that his current efforts as head of the Fraud Discovery Institute and as pastor of The Community Bible Church in San Diego will supersede his activities as CEO of the carpet-cleaning company. This month his new book, Cleaning Up (Nelson Current), debuts.

1. Currently, you are fighting the very crime you were convicted of. Isn't that ironic?
No one failed worse than I did at such a young age. Sure, you can adjust the dollar amounts and say it was $10 billion with Bernie Ebbers at WorldCom, but it doesn't matter. I was CEO of a public company and I failed. [ZZZZ Best] was a fully reporting public company with a stock that went from $12 to $80. And at 21, I got a 25-year sentence and a $26 million restitution order, and that's [since been] turned into $1 billion in fraud uncoverings.

2. What can other white-collar criminals glean from your mistakes?
Jeff Skilling's and Andy Fastow's best days are ahead of them...if they admit they did wrong, do whatever they can to pay back their victims, and use the same talents they used to defraud people to help them.

3. When you speak to executives about fraud, what's your main message?
When I speak to executives, I wear my orange prison jumpsuit. It's gimmicky... [but] the best way to stop fraud is to talk people out of perpetrating it in the first place by doing two things: increasing the perception of detection and increasing the perception of prosecution.

4. Are you surprised that the fraud techniques you used are still out there?
It doesn't surprise me at all. Long before Enron was touring people on phony trading floors, ZZZZ Best was touring people on buildings for restoration jobs that we never did. Now the variation on a theme is always there, but here's what we do: we lie about what we owe and we lie about what we earn.

5. On what do you blame the rash of corporate fraud in recent years?
It's a mentality called right equals forward motion and wrong is anyone who gets in my way. You see, we used to endorse character and integrity, but today the business ethic that reigns is achievement. And whenever you establish the worth of someone based on what they can do and not on who they are, you have created the environment for fraud.

6. Are you skeptical of efforts, such as Sarbanes-Oxley, to legislate ethics?
Let me tell you why this legislation is brilliant. Sarbox hit at a common denominator of corporate fraud: bypassing systems of internal controls. I would not have been able to perpetrate the ZZZZ Best fraud if I had not been able to bypass the system of internal controls. And you know who are heroes now — the internal auditors and the Public Company Accounting Oversight Board. Unless you're a perpetrator, you don't know how good these moves are.

7. Should the sentencing guidelines for white-collar criminals be overhauled?
Yes, and judges should have more discretion. My judge is the one who said that I had no conscience. Two years ago, he dismissed my $26 million restitution order, dismissed me from probation three years early, and told me to go out and fight corporate fraud. [But] I don't care if anyone goes to jail. The number-one thing white-collar criminals need to do is give the money back to those hurt the most.

8. When will you be satisfied that you've repaid your debt to society?
I won't be. Union Bank had a $7 million loan [against ZZZZ Best], and I have a long way to go. But I haven't missed a payment in nine years. They've gotten over $100,000 this year alone.

9. Why is there so much investment fraud?
What we have is a perfect fraud storm. In places across the country with an appreciating housing market, low interest rates, and consumers dissatisfied with Wall Street returns, you'll find people ripe for [perpetrators].

10. What do you say to those who doubt your conversion to the straight and narrow?
There's this great phrase in the Bible: "When the man's ways please the Lord, he makes even his enemies be at peace with him." The biggest critics of Barry Minkow should be law enforcement. They absolutely know if someone is a fake or real. But they've been my biggest supporters.

Forensic Accounting
There’s a rather nice module on Forensic Accounting at http://en.wikipedia.org/wiki/Forensic_Accounting
This includes links to a journal and career opportunities.

The link to the following article was forwarded by Charles Wankel [wankelc@VERIZON.NET]

"Account for more than hill of beans," The Bay City Times Via The Saginaw News, December 16, 2007 --- Click Here

When Kojo Quartey went to college to learn accounting 25 years ago, many considered the job a steady, unexciting career.

But financial scandals in recent years at Enron, WorldCom and other companies have transformed the field, says Quartey, dean of Davenport University's Donald W. Maine School of Business.

''When I was an accounting student, we were all number crunchers. In this day and age, it's a much more exciting field,'' he said.

Many accountants today are seeking specialized training to work as detectives who can sniff out financial fraud. They call themselves forensic accountants.

Davenport, a Grand Rapids-based university with branches at 5300 Bay in Kochville Township and at 3930 Traxler Court in Bay County's Monitor Township, has two online offerings in the growing field. One is a new bachelor's degree in business administration in accounting fraud investigation and the other is a forensic accounting examiner certificate available to postgraduates.

Forensic accountants undergo training to mind the books while keeping an eye out for crime.

Demand for accountants who have such training is skyrocketing, Quartey told a group of Bay and Arenac county high school counselors.

In addition to traditional accounting, forensic accountants may learn from law enforcement experts about how to detect fraud, and from psychologists about how to interview people to detect lying, Quartey said.

Irene Bembenista teaches classes at Davenport required for the forensic examiner certificate.

''It's not just how to do an audit, but what are some of the clues that would indicate something more is going on? And ideas about where to further investigate,'' said Bembenista, Davenport's associate business school dean.

Bembenista said 10 years ago, people did not generally recognize forensic accounting as a college career path.

A federal law enacted in 2002 to reform accounting has brought the investigation field into its own. It's also created job opportunities because it requires accountants at public entities to maintain a separation of duties, Bembenista said.

''Accountants aren't allowed to do double duties, like taxes and audit the company at the same time,'' she said.

''And businesses are very interested in accountants with a fraud (detection) background, because they are looking out for the well-being of the organization.''

The starting salary for an accounting fraud investigator is $48,000 to $60,000 a year, and certified forensic examiners can earn more than $100,000 a year, Davenport says compensation studies indicate.

Davenport has about two dozen students enrolled in the forensic accounting certificate curriculum, Quartey said. The next term begins in January, and more information is available on the Internet at www.davenport.edu

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

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

Cooking the Books

 

Before reading this, you may want to read about creative accounting and earnings management at http://en.wikipedia.org/wiki/Earnings_management

From Jim Mahar's blog on November 5, 2007 --- http://financeprofessorblog.blogspot.com/
Does short-term debt lead to more "earnings management"?

 

In another paper from the FMAs, Gupta and Fields look at whether more short term debt leads to more "earnings management."

Does short-term debt lead to more "earnings management"?

Short answer: YES.

Longer answer:

Intuitively the idea behind the paper is that if a firm has to go back to the capital markets, they do not want to do so when times are bad. Of course, sometimes times are bad. In those times, management may be tempted to "manage" earnings so that things do not appear as bad as they may be.

The findings? Sure enough, managers seemingly manage their firm's earnings more when the firm has more short term debt.

A few look-ins:

From the Abstract (this is the best summary of the entire paper):
 

"...results indicate that (i) firms with more current debt are more susceptible to managing earnings, (ii) this relation is stronger for firms facing debt market constraints (those without investment grade debt) and (iii) auditor characteristics such as auditor quality and tenure help diminish this relation...."
 

Which fits intuition. Why?
* The more the constraints, the more incentive the management has to manage earnings since if they do not, they may not be able to refinance.
* Auditors would frown upon this behavior and the stronger the auditor, the less likely it is that the manager would manage earnings.

How does this "earnings management" manifest itself? The most common way (although not the only way) that managers manipulate earnings is through the use of accruals . Thus, the authors examine this and find:
 

"A one standard-deviation increase in short-term debt (total current liabilities) increases discretionary accruals by 1.69% and increase total accruals by 2.28%. Our evidence supports the idea that debt maturity significantly impacts the tendency of firms to manage earnings."
 

Which is a really interesting finding!

Sharing Site of Note --- http://www.dartmouth.edu/~msimmons/ 
Thank you Mark Simmons at Dartmouth for sharing internal auditing and fraud investigation resources.

Web Site of Mark R. Simmons, CIA CFE

This site focuses on topics that deal with Internal Auditing and Fraud Investigation with certain links to other associated and relevant sources. It is dedicated to sharing information. Internal Auditing is an independent, objective assurance and consulting activity designed to add value and improve an organization's operations.  It helps an organization accomplish its objectives by bringing a systematic, disciplined approach to evaluate and improve the effectiveness of risk management, control, and governance processes. (Institute of Internal Auditors) Fraud Investigation consists of the multitude of steps necessary to resolve allegations of fraud — interviewing witnesses, assembling evidence, writing reports, and dealing with prosecutors and the courts. (Association of Certified Fraud Examiners)

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

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

"Rash of Restatements Rattles," by K.C. Swanson, TheStreet.com, March 17, 2004 http://www.thestreet.com/tech/kcswanson/10149112.html 

Confession season is upon us, but the problem so far isn't companies owing up to earnings shortfalls. Instead, they're admitting past financial results were simply wrong.

Unnerved by a sterner accounting culture, companies have been increasingly reaching back years to ratchet down reported profits by tens or even hundreds of millions of dollars. Eyeing the March 15 filing deadline for calendar 2003 annual reports, Bristol-Myers Squibb (BMY:NYSE) , P.F. Chang's (PFCB:Nasdaq) , Veritas (VRTS:Nasdaq) and Nortel (NT :Nasdaq) this week joined a fast-growing string of public companies to say prior financial reports inflated real business trends.

The number of restated audited annual financial statements hit a record high of 206 last year, according to Chicago-based Huron Consulting Group. Observers say 2004 is already shaping up as a banner year for revisions.

"There are certainly more high-profile restatements and you're hearing about them more" compared to past years, said Jeff Brotman, an accounting professor at the University of Pennsylvania.

For Bristol-Myers Squibb, Nortel and Network Associates (NET:NYSE) , recent restatements came on top of prior restatements, much to the irritation of investors. In at least two cases, the embarrassing double restatements prompted internal shifts; Nortel put two of its financial executives on leave as part of a bookkeeping probe. Network Associates fired PricewaterhouseCoopers, according to various news reports, after the auditor cited "material weakness" in its internal controls in the company's annual report.

Probably the biggest reason for the wave of honesty is a host of new corporate governance and accounting rules in the wake of the corporate reform legislation known as Sarbanes-Oxley, which went into effect a year and a half ago. Also, accounting firms have grown far more cautious, cowed by the collapse of auditor Arthur Andersen in 2002 after massive fraud at its client Enron.

The upshot is that both managers and auditors are now more likely to err on the side of conservative accounting.

"A lot of things in accounting are judgment calls, gray areas," said Peter Ehrenberg, chair of the corporate finance practice group at Lowenstein & Sandler, a Roseland, N.J.-based law firm. "If there are issues in any given company and we were in 2000, a person acting in good faith might easily say, 'We can pass on that.' But that same person looking at the same facts today might say, 'There's too much risk.'

"Certainly regulators in general are more credible because they're much less likely to give the benefit of the doubt in this environment," he added. "The auditors know that and they're [therefore] less likely to stick their necks out."

Case in point: Last week Gateway (GTW:NYSE) said longtime auditor PricewaterhouseCoopers won't work for it anymore. PwC did the books back in 2000 and 2001 -- an era of aggressive accounting that still haunts Gateway, though it's now under different management.

From Executive Suite to Cell Block

Tougher law enforcement against corporate offenders is also fueling more prudent behavior. The long-underfunded Securities and Exchange Commission, which is now required to review the financial statements of public companies every three years, has finally been given more dollars to hire staff. In 2003, the SEC's workforce was 11% higher than in 2001. This year, the agency's budget allocation should allow it to expand its payroll an additional 9%, to nearly 3,600 employees.

On the corporate side, CEOs and CFOs have had to certify their financial reports since August 2002, also as a result of Sarbanes-Oxley. "I think Sarbanes-Oxley makes executives ask the hard questions they should have always asked," said Jeffrey Herrmann, a securities litigator and partner in the Saddle Brook, N.J.-based law firm of Cohn Lifland Pearlman Herrmann & Knopf. "Maybe today an executive says to his accounting firm: 'I'm not going to regret anything here about how we handled goodwill or reserves, am I? It isn't coming back to haunt us, is it?' "

Recent government prosecutions against high-level executives such as Tyco's Dennis Kozlowski, Worldcom's Bernie Ebbers, and Enron's Andrew Fastow and Jeffrey Skilling starkly underscore the penalties managers may face for playing fast-and-loose with accounting.

Meanwhile, auditing firms are starting to rotate staff, bringing in newcomers to take a fresh look at clients' accounting. Also, new rules handed down by the Financial Accounting Standards Board have prompted reassessments of past accounting methods, which can lead to earnings revisions reaching back five years (the period for which financial data is included in annual reports).

Another level of checks and balances on accounting shenanigans arrived last April when the SEC ruled that corporate audit committees must be composed entirely of members independent from the company itself. "Audit committees are getting more active and making sure that when they learn of problems, they're going to be dealt with," said Curtis Verschoor, an accounting professor at DePaul University.

In this environment of heightened scrutiny, however, the notion that a restatement was tantamount to a financial kiss of death has faded, too.

"We have now seen companies that issued restatements that have lived to do business another day," said Brotman. "The stock hasn't crashed; nobody's been fired or gone to jail; they haven't lost access to the capital markets; there haven't been any more shareholder lawsuits than there would have already been. If a company does a restatement early, fully and explains exactly what it is and why, it's not a lethal injection."

Meanwhile, corporate reform rules are being put in place that could lead to yet more accounting cleanups down the road. One provision will make companies find a way for whistleblowers to confidentially report possible wrongdoings, noted Verschoor.

Still, "the pendulum swings both ways," said Herrmann. "If the government continues to prosecute people in high-level positions, maybe that will last for a while. It probably will send a message and the fear of God will spread. But my guess is that politics being what it is, somewhere down the line the spotlight will be off and there will be fewer prosecutions."

A Round-Up of Recent Earnings Restatements Some firms are no stranger to the restatement dance
Company	Financial Scoop	Number of restatements in past year
Bristol-Myers Squibb (BMY:NYSE)	Restating fourth-quarter and full-year results for 2003 due to accounting errors. Follows an earlier restatement of earnings between 1999 and 2002, as of early 2003	Twice
P.F. Chang's China Bistro (PFCB:Nasdaq)	Will delay filing its 10K; plans to restate earnings for prior years, including for calendar year 2003	Once
Veritas (VRTS:Nasdaq)	Will restate earnings for 2001 through 2003	Once
Nortel (NT:NYSE)	Will restate earnings for 2003 and earlier periods; Nortel already restated earnings for the past three years in October 2003	Twice
Metris (MXT:NYSE)	Restated its financial results for 1998 through 2002 and for the first three quarters of 2003 following an SEC inquiry	Once
Quovadx (QVDX:Nasdaq)	Restating results for 2003	Once
WorldCom	Restated pretax profits from 2000 and 2001; this month former CEO Bernie Ebbers indicted on fraud charges in accounting scandal that led to 2002 corporate bankruptcy	Once
Service Corp. International (SRV:NYSE)	Restating results for 2000 through 2003	Once
Flowserve (FLS:NYSE)	Restating results for 1999 through 2003	Once
OM Group (OMG:NYSE)	Restating results for 1999 through 2003	Once
IDX Systems (IDXC:Nasdaq)	Restated results for 2003	Once
Network Associates (NET:NYSE)	Restated results for 2003 this month; restated earnings for periods from 1998 to 2003 after investigations by the SEC and Justice Department	Twice
Take-Two (TTWO:Nasdaq)	In February, restated results from 1999 to 2003 following investigation by the SEC	Once
Sipex (SIPX:Nasdaq)	In February, restated results from 2003, marking the second revision of third-quarter '03 results	Twice
Source: SEC filings, media reports.

March 1, 2004 message from Mike Groomer

Bob,

Do you have any idea about who coined the phrase “Cooking the Books? What is the lineage of these magic words?

Mike

Hi Mike,

The phrase "cooking the books" appears to have a long history. Several friends on the AECM found some interesting facts and legends.

However, there may be a little urban legend in some of this.

I suspect that the phrase may have origins that will never be determined much like double entry bookkeeping itself with unknown origins. And I'm not sure were the term "books" first appeared although I suspect it goes back to when ledgers were bound into "books."

Bob Jensen

March 1 messages from David Albrecht [albrecht@PROFALBRECHT.COM] 

-----Original Message----- 
From: David Albrecht 
Sent: Monday, March 01, 2004 9:56 PM 
Subject: Acct 321: Cooking the books

The phrase "Cooking the Books" has been part of our linguistic heritage for over two hundred years. Here is a discussion of the origination of the phrase. Enjoy! Dr. Albrecht

 http://www.wordwizard.com/clubhouse/founddiscuss1.asp?Num=3093 

---

Just found another page.

from http://www.wordwizard.com/clubhouse/founddiscuss1.asp?Num=3093 

---

I'm doing a google search. Interesting links so far:

Cost to society of cooking the books - from Brookings Institute http://www.brookings.edu/comm/policybriefs/pb106.htm

Cookie jar accounting - http://www.investorwords.com/1121/cookie_jar_accounting.html

The bubbling corporate ethics scandal and recipes for avoiding future stews. - http://research.moore.sc.edu/Publications/B&EReview/B&E49/Be49_3/cooking.htm

Andersen cartoon - http://www.claybennett.com/pages/andersen.html

Cooking the Books with Mike - http://www.moneytalks.net/book.asp

Cartoons - http://www.cartoonstock.com/directory/c/cooking_the_books.asp

Cooking the books, an old recipe - http://www.accountantsworld.com/DesktopDefault.aspx?tabid=2&faid=290 --> "No one knows for sure when all the ingredients in the phrase 'cooking the books' were first put together. Shakespeare was the first to refer to "books" as a business ledger (King Lear, Act III, Scene iv, "Keep...thy pen from lenders books"). The American Heritage Dictionary of Idioms cites 1636 as the first time the word 'cook' was used to mean falsify (but it didn't also include the word 'books'). Combining 'cook' and 'books' may be a 20th century innovation. Even the origin of "cooking the books" is controversial.

This is all I have time to search,

David Albrecht

March 1, 2004 reply from Roy Regel [Roy.Regel@BUSINESS.UMT.EDU] 

A related term is "cookbooking," as used in Gleim's 'Careers in Accounting: How to Study for Success.' Per Gleim ". . .cookbooking is copying from the chapter illustration, step-by-step. Barely more than rote memorization is required to achieve false success. Do not cookbook!"

Isn't English wonderful? :)

Roy Regel

March 1, 2004 reply from Richard C. Sansing [Richard.C.Sansing@DARTMOUTH.EDU] 

According to http://www.businessballs.com/clichesorigins.htm , the phrase dates back to the 18th century, to an (unattributed) report that used the phrase "the books have been cooked." The report dealt with the conduct of George Hudson and the accounts of the Eastern Counties Railways.

Richard Sansing

Following up on Richard Sansing's lead, Mike answered his own question --- http://www.businessballs.com/clichesorigins.htm 

Bob Jensen

Original Message----- 
From: Groomer, S. Michael [mailto:groomer@indiana.edu]  
Sent: Tuesday, March 02, 2004 9:40 AM 
To: Jensen, Robert Subject: RE: Acct 321: Cooking the books

Hi Bob,

Yes… very interesting… See below… Thanks for your efforts.

Best regards, Mike

cook the books - falsify business accounts - according to 18th century Brewer, 'cook the books' originally appeared as the past tense 'the books have been cooked' in a report (he didn't name the writer unfortunately) referring to the conduct George Hudson (1700-71), 'the railway king', under whose chairmanship the accounts of Eastern Counties Railways were falsified. Brewer says then (1870) that the term specifically describes the tampering of ledger and other trade books in order to show a balance in favour of the bankrupt. Brewer also says the allusion is to preparing meat for the table. These days the term has a wider meaning, extending to any kind of creative accounting. Historical records bear this out, and date the first recorded use quite accurately: Hudson made a fortune speculating in railway shares, and then in 1845, which began the period 1845-47 known as 'railway mania' in Britain, he was exposed as a fraudster and sent to jail. Other cliche references suggest earlier usage, even 17th century, but there appears to be no real evidence of this. There is an argument for Brewer being generally pretty reliable when it comes to first recorded/published use, because simply he lived far closer to the date of origin than reference writers of today. If you read Brewer's Dictionary of Phrase and Fable you'll see it does have an extremely credible and prudent style. The word 'book' incidentally comes from old German 'buche' for beech wood, the bark of which was used in Europe before paper became readily available. The verb 'cook' is from Latin 'coquere'

Risk-Based Auditing Under Attack   

How to Pass Price Risk Along to Uncle Sam
Agribusiness Lobby Reaps the Biggest Harvest in Washington DC

A farmer can sell his crop early at a high price, say, in a futures contract, and still collect a subsidy check after the harvest from the government if prices are down over all. The money is not tied to what the farmer actually received for his crop. The farmer does not even have to sell the crop to get the check, only prove that the market has dropped below a certain set rate.
"Big Farms Reap Two Harvests With Subsidies a Bumper Crop," by Timothy Egan, The New York Times, December 26, 2005 --- http://www.nytimes.com/2004/12/26/national/26farm.html?oref=login  

The roadside sign welcoming people into this state reads: "Nebraska, the Good Life." And for farmers closing out their books at the end of a year when they earned more money than at any time in the history of American agriculture, it certainly looks like happy days.

But at a time when big harvests and record farm income should mean that Champagne corks are popping across the prairie, the prosperity has brought with it the kind of nervousness seen in headlines like the one that ran in The Omaha World-Herald in early December: "Income boom has farmers on edge."

For despite the fact that farm income has doubled in two years, federal subsidies have also gone up nearly 40 percent over the same period - projected at $15.7 billion this year, and $130 billion over the last nine years. And that bounty is drawing fire from people who say that at this moment of farm prosperity, the nation's subsidy system has never made less sense.

Even those deeply steeped in the system acknowledge it seems counterintuitive. "I struggle with the same question: how the hell can you have such high government payments if farmers had such a great year?" said Keith Collins, the chief economist for the Agriculture Department.

The answer lies in the quirks of the federal farm subsidy system as well as in the way savvy farmers sell their crops. Mr. Collins said farmers use the peculiar world of agriculture market timing to get both high commodity prices and high subsidies.

"The biggest reason is with record crops, prices have fallen," he said. "And farmers are taking advantage of that."

A farmer can sell his crop early at a high price, say, in a futures contract, and still collect a subsidy check after the harvest from the government if prices are down over all. The money is not tied to what the farmer actually received for his crop. The farmer does not even have to sell the crop to get the check, only prove that the market has dropped below a certain set rate.

Continued in article

Bob Jensen's threads on futures contracts and other derivative financial instruments are at http://www.trinity.edu/rjensen/caseans/000index.htm 

References

Risk-Based Auditing Under Attack   

From Smart Stops on the Web, Journal of Accountancy, January 2004, Page 27 --- 

Accountability Resources Here
www.thecorporatelibrary.com
CPAs can read about corporate governance in the real world in articles such as “Alliance Ousts Two Executives” and “Mutual Fund Directors Avert Eyes as Consumers Get Stung” at this Web site. Other resources here include related news items from wire services and newspapers, details on specific shareholder action campaigns and links to other corporate governance Web stops. And on the lighter side, visitors can view a slide show of topical cartoons.

Cartoon archives --- http://www.thecorporatelibrary.com/cartoons/tcl_cartoons.htm

Cartoon 1:  Two kids competing on the blackboard.  One writes 2+2=4 and the other kid writes 2+2=40,000.  Which kid as the best prospects for an accounting career?

Cartoon 36:  Where the Grasso is greener (Also see Cartoon 37)

 

Show-and-Tell
www.encycogov.com
This e-stop, while filled with information on corporate governance, also features detailed flowcharts and tables on bankruptcy, information retrieval and monitoring systems, as well as capital, creditor and ownership structures. Practitioners will find six definitions of the term corporate governance and a long list of references to books, papers and periodicals about the topic.

Investors, Do Your Homework
www.irrc.org
At this Web site CPAs will find the electronic version of the Investor Responsibility Research Center’s IRRC Social Issues Reporter, with articles such as “Mutual Funds Seldom Support Social Proposals.” Advisers also can read proposals from the Shareholder Action Network and the IRRC’s review of NYSE and Sarbanes-Oxley Act reforms, as well as use a glossary of industry terms to help explain to their clients concepts such as acceleration, binding shareholder proposal and cumulative voting.

 

SARBANES-OXLEY SITES

Get Information Online
www.sarbanes-oxley.com
CPAs looking for links to recent developments on the Sarbanes-Oxley Act of 2002 can come here to review current SEC rules and regulations with cross-references to specific sections of the act. Visitors also can find the articles “Congress Eyes Mutual Fund Reform” and “FBI and AICPA Join Forces to Help CPAs Ferret Out Fraud.” Tech-minded CPAs will find the list of links to Sarbanes-Oxley compliance software useful as well.

Direct From the Source
www.sec.gov/spotlight/sarbanes-oxley.htm
To trace the history of the SEC’s rule-making policies for the Sarbanes-Oxley Act, CPAs can go right to the source at this Web site and follow links to press releases pertaining to the commission’s involvement since the act’s creation. Visitors also can navigate to the frequently asked questions (FAQ) section about the act from the SEC’s Division of Corporation Finance.

PCAOB Online
www.pcaobus.org
The Public Company Accounting Oversight Board e-stop offers CPAs timely articles such as “Board Approves Registration of 598 Accounting Firms” and the full text of the Sarbanes-Oxley rules. Users can research proposed standards on accounting support fees and audit documentation and enforcement. Accounting firms not yet registered with the PCAOB can do so here and check out the FAQ section about the registration process.

Where are some great resources (hard copy and electronic) for teaching ethics?

"An Inventory of Support Materials for Teaching Ethics in the Post-Enron Era,” by C. William Thomas, Issues in Accounting Education, February 2004, pp. 27-52 --- http://aaahq.org/ic/browse.htm

ABSTRACT: This paper presents a "Post-Enron" annotated bibliography of resources for accounting professors who wish to either design a stand-alone course in accounting ethics or who wish to integrate a significant component of ethics into traditional courses across the curriculum.  Many of the resources listed are recent, but some are classics that have withstood the test of time and still contain valuable information.  The resources listed include texts and reference works, commercial books, academic and professional articles, and electronic resources such as film and Internet websites.  Resources are listed by subject matter, to the extent possible, to permit topical access.  Some observations about course design, curriculum content, and instructional methodology are made as well.

Bob Jensen's threads on resources for accounting educators are at http://www.trinity.edu/rjensen/000aaa/newfaculty.htm#Resources 

Discount retailer Kmart is under investigation for irregular accounting practices. In January an anonymous letter initiated an internal probe of the company's accounting practices. Now, the Detroit News has obtained a copy of the letter that contains allegations pointing to senior Kmart officials as purposely violating accounting principles with the knowledge of the company's auditors, PricewaterhouseCoopers. http://www.accountingweb.com/item/82286 

Bankrupt retailer Kmart explained the impact of accounting irregularities and said employees involved in questionable accounting practices are no longer with the company. http://www.accountingweb.com/item/90935 

Kmart's CFO Steps up to Accounting Questions

AccountingWEB US - Sep-19-2002 -  Bankrupt retailer Kmart explained the impact of accounting irregularities in a Form 10-Q filed with the U.S. Securities and Exchange Commission (SEC) this week. Chief Financial Officer Al Koch said several employees involved in questionable accounting practices are no longer with the company. Speaking to the concerns about vendor allowances recently raised in anonymous letters from in-house accountants, Mr. Koch said, "It was not hugely widespread, but neither was it one or two people." The Kmart whistleblowers who wrote the letters said they were being asked to record transactions in obvious violation of generally accepted accounting principles. They also said "resident auditors from PricewaterhouseCoopers are hesitant to pursue these issues or even question obvious changes in revenue and expense patterns." In response to the letters, the company admitted it had erroneously accounted for certain vendor transactions as up-front consideration, instead of deferring appropriate amounts and recognizing them over the life of the contract. It also said it decided to change its accounting method. Starting with fourth quarter 2001, Kmart's policy is to recognize a cost recovery from vendors only when a formal agreement has been obtained and the underlying activity has been performed. According to this week's Form 10-Q, early recognition of vendor allowances resulted in understatement of the company's fiscal year 2000 net loss by approximately $26 million and overstatement of its fiscal year 2001 net loss by approximately $78 million, both net of taxes. The 10-Q also said the company has been looking at historical patterns of markdowns and markdown reserves and their relation to earnings. Kmart is under investigation by the SEC and the Justice Department. The Federal Bureau of Investigation, which is handling the investigation for the U.S. Attorney, said its investigation could result in criminal charges. In the months before Kmart's bankruptcy filing, top executives took home approximately $29 million in retention loans and severance packages. A spokesperson for PwC said the firm is cooperating with the investigations.

24 Days: How Two Wall Street Journal Reporters Uncovered the Lies that Destroyed Faith in Corporate America, by John R. Emshiller and Rebecca Smith (Haper Collins, 2003, ISBN: 0060520736) 

Here's a powerful Enron Scandal book in the words of the lead whistle blower herself:
Power Failure: The Inside Story of the Collapse of Enron
by Mimi Swartz, Sherron Watkins

ISBN: 0385507879 Format: Hardcover, 400pp Pub. Date: March 2003

Publisher: Doubleday & Company, Incorporated Edition Description: 1ST

“They’re still trying to hide the weenie,” thought Sherron Watkins as she read a newspaper clipping about Enron two weeks before Christmas, 2001. . . It quoted [CFO] Jeff McMahon addressing the company’s creditors and cautioning them against a rash judgment....

Related Books

• Pipe Dreams: Greed, Ego, and the Death of Enron Robert Bryce, Molly Ivins
• Anatomy of Greed: The Unshredded Truth from an Enron Insider Brian Cruver
• Martha Inc.: The Incredible Story of Martha Stewart Living Omnimedia Christopher M. Byron
• Pigs at the Trough: How Corporate Greed and Political Corruption Are Undermining America Arianna Huffington

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. 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.
The AccountingWeb, March 25, 2003.

Barbara Ley Toffler is the former Andersen was the partner-in-charge of 
Andersen's Ethics & Responsible Business Practices Consulting Services.

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 

March 8, 2004 message from neil glass [neil.glass@get2net.dk] 
Note that you can download the first chapter of his book for free.  The book may be purchased as an eBook or hard copy.

Dr. Jensen,

I just came across your website and was pleased to find you talk about some of the frauds and other problems I reveal in my latest book. If you had a moment, you might be amused to look at my website only-on-the-net.com where I am trying to attract some attention to my book Rip-Off: The scandalous inside story of the Management Consulting Money Machine.

best wishes

neil glass

The link is http://www.only-on-the-net.com/ 

The AICPA's Prosecution of Dr. Abraham Briloff, Some Observations --- http://accounting.rutgers.edu/raw/aaa/pi/newsletr/spring99/item07.htm 

Art Wyatt admitted:
"ACCOUNTING PROFESSIONALISM: THEY JUST DON'T GET IT" --- http://aaahq.org/AM2003/WyattSpeech.pdf 

Here is some earlier related material you can find at http://www.trinity.edu/rjensen/fraudVirginia.htm 

May 15, 2003 message from Dave Albrecht [albrecht@PROFALBRECHT.COM] 

I've been teaching Intermediate Financial Accounting for several years. Recently, I've been thinking about having students read a supplemental book . Given the current upheaval, there are several possibilities for additional reading. Can anyone make a recommendation? BTW, these books would make great summer reading.

Dave Albrecht

Benston et. al. (2003). Following the Money: The Enron Failure and the State of Corporate Disclosure.

Berenson, Alex. (2003). The Number: How the Drive for Quarterly Earnings Corrupted Wall Street and Corporate America.

Brewster, Mike. (2003). Unaccountable: How the Accounting Profession Forfeited an Public Trust.

Brice & Ivins. (2002.) Pipe Dreams: Greed, Ego and the Death of Enron.

DiPiazza & Eccles. (2002). Building Public Trust: The Future of Corporate Reporting.

Fox, Loren. (2002). Enron, the Rise and Fall.

Jeter, Lynne W. (2003). Disconnected: Deceit and Betrayal at WorldCom.

Mills, D. Quinn. (2003). Wheel, Deal and Steal: Deceptive Accounting, Deceitful CEOs, and Ineffective Reforms.

Mulford & Comiskey. (2002). The Financial Numbers Game: Detecting Creative Accounting Practices.

Nofsinger & Kim. (2003). Infectious Greed: Restoring Confidence in America's Companies.

Squires, Susan. (2003). Inside Arthur Andersen: Shifting Values, Unexpected Consequences.

Swartz & Watkins. (2003). Power Failure: The Inside Story of the Collapse of Enron.

Toffler, Barbara. (2003). Final Accounting: Ambition, Greed and the Fall of Arthur Andersen

May 15, 2003 reply from Bruce Lubich [blubich@UMUC.EDU] 

I would add Schilit, Howard. (2002) Financial Shenanigans.

Bruce Lubich

May 15, 2003 reply from Neal Hannon [nhannon@COX.NET] 

Suggested Additions to Summer Book List:

Financial Shenanigans : How to Detect Accounting Gimmicks & Fraud in Financial Reports by Howard Schilit (McGraw-Hill Trade; 2nd edition (March 1, 2002))

How Companies Lie: Why Enron Is Just the Tip of the Iceberg by Richard J. Schroth, A. Larry Elliott

Quality Financial Reporting by Paul B. W. Miller, Paul R. Bahnson

Take On the Street: What Wall Street and Corporate America Don't Want You to Know by Arthur Levitt, Paula Dwyer (Contributor)

And for fun: Who Moved My Cheese? An Amazing Way to Deal with Change in Your Work and in Your Life by Spencer, M.D. Johnson, Kenneth H. Blanchard

Neal J. Hannon, CMA Chair, I.T. Committee, Institute of Management Accountants Member, XBRL_US Steering Committee University of Hartford (860) 768-5810 (401) 769-3802 (Home Office)

Book Recommendation from The AccountingWeb on April 25, 2003

The professional service accounting firm is being threatened by a variety of factors: new technology, intense competition, consolidation, an inability to incorporate new services into a business strategy, and the erosion of public trust, just to name a few. There is relief. And promise. And hope. In The Firm of the Future: A Guide for Accountants, Lawyers, and Other Professional Services, confronts the tired, conventional wisdom that continues to fail its adherents, and present bold, proven strategies for restoring vitality and dynamism to the professional service firm. http://www.amazon.com/exec/obidos/ASIN/0471264245/accountingweb 

Question
What is COSO?

Answer --- http://www.coso.org/ 

COSO is a voluntary private sector organization dedicated to improving the quality of financial reporting through business ethics, effective internal controls, and corporate governance. COSO was originally formed in 1985 to sponsor the National Commission on Fraudulent Financial Reporting, an independent private sector initiative which studied the causal factors that can lead to fraudulent financial reporting and developed recommendations for public companies and their independent auditors, for the SEC and other regulators, and for educational institutions.

The National Commission was jointly sponsored by the five major financial professional associations in the United States, the American Accounting Association, the American Institute of Certified Public Accountants, the Financial Executives Institute, the Institute of Internal Auditors, and the National Association of Accountants (now the Institute of Management Accountants). The Commission was wholly independent of each of the sponsoring organizations, and contained representatives from industry, public accounting, investment firms, and the New York Stock Exchange.

The Chairman of the National Commission was James C. Treadway, Jr., Executive Vice President and General Counsel, Paine Webber Incorporated and a former Commissioner of the U.S. Securities and Exchange Commission. (Hence, the popular name "Treadway Commission"). Currently, the COSO Chairman is John Flaherty, Chairman, Retired Vice President and General Auditor for PepsiCo Inc.

Title:  ENRON: A Professional's Guide to the Events, Ethical Issues, and Proposed Reforms 
Authur: L. Berkowitz, CPA
ISBN: 0-8080-0825-0
Publisher:  CCH --- http://tax.cchgroup.com/Store/Products/CCE-CCH-1959.htm?cookie%5Ftest=1 
Pub. Date:  July 2002

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 

Don Ramsey called my attention to the following audio interview:
For a one-hour audio archive of Diane Rehm's recent interview with Arthur Levitt, go to this URL:   http://www.wamu.org/ram/2002/r2021015.ram

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

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

From The Conference Board
Corporate Citizenship in the New Century: Accountability, Transparency, and Global Stakeholder Engagement
Publication Date:  July 2002
Report Number:  R-1314-02-RR --- http://www.conference-board.org/publications/describe.cfm?id=574 

My new and updated documents the recent accounting and investment scandals are at the following sites:

Bob Jensen's threads on the Enron/Andersen scandals are at  http://www.trinity.edu/rjensen/fraud.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? --- http://www.trinity.edu/rjensen/fraudVirginia.htm 

Disconnected: Deceit and Betrayal at WorldCom, by Lynne W. Jeter

Inside Arthur Andersen: Shifting Values, Unexpected Consequences by Lorna McDougall, Cynthia Smith, Susan E. Squires, William R. Yeack.

Final Accounting: Ambition, Greed and the Fall of Arthur Andersen by Barbara Ley Toffler and Jennifer Reingold

Bisk CPEasy's "Accounting Profession Reform: Restoring Confidence in the System" --- http://www.cpeasy.com/ 

"The fall of Andersen," Chicago Tribune --- http://www.chicagotribune.com/business/showcase/chi-andersen.special 

Chicago's Andersen accounting firm must stop auditing publicly traded companies following the firm's conviction for obstructing justice during the federal investigation into the downfall of Enron Corp. For decades, Andersen was a fixture in Chicago's business community and, at one time, the gold standard of the accounting industry. How did this legendary firm disappear?

Civil war splits Andersen
September 2, 2002.  Second of four parts

The fall of Andersen
September 1, 2002.  This series was reported by Delroy Alexander, Greg Burns, Robert Manor, Flynn McRoberts and E.A. Torriero. It was written by McRoberts.

Greed tarnished golden reputation
September 1, 2002.  First of four parts

'Merchant or Samurai?'
September 1, 2002.  Dick Measelle, then-chief executive of Andersen's worldwide audit and tax practice, explores a corporate cultural divide in an April 1995 newsletter essay to Andersen partners.

What will the U.S. accounting business look like when the dust settles on Arthur Andersen? http://www.trinity.edu/rjensen/fraud041202.htm#Future 
Also see http://www.trinity.edu/rjensen/FraudConclusion.htm 

The Washington Post put together a terrific Corporate Scandal Primer that includes reviews and pictures of the "players," "articles,", and an "overview" of each major accounting and finance scandal of the Year 2002 --- http://www.washingtonpost.com/wp-srv/business/scandals/primer/index.html 
I added this link to my own reviews at http://www.trinity.edu/rjensen/fraud.htm#Governance

The AccountingWeb recommends a number of books on accounting fraud --- http://www.amazon.com/exec/obidos/ASIN/0471353787/accountingweb/103-6121868-8139853 

• The Fraud Identification Handbook by George B. Allen (Preface)
• Financial Investigation and Forensic Accounting by George A. Manning
• Business Fraud by James A. Blanco, Dave Evans
• Document Fraud and Other Crimes of Deception by Jesse M. Greenwald, Holly K. Tuttle (Illustrator)
• Fraud Auditing and Forensic Accounting by Jack Bologna, et al
• The Financial Numbers Game by Charles W. Mulford, Eugene E. Comiskey
• How to Reduce Business Losses from Employee Theft and Customer Fraud by Alfred N. Weiner
• Financial Statement Fraud by Zabihollah Rezaee, Joseph T. Wells
• Transnational Criminal Organizations, Cybercrime, and Money Laundering by James R. Richards

Yahoo's choices for top fraud sites --- http://dir.yahoo.com/Society_and_Culture/Crime/Types_of_Crime/Fraud/Finance_and_Investment/ 

You might enjoy "The AICPA's Prosecution of Dr. Abraham Briloff: Some Observations," by Dwight M. Owsen --- http://accounting.rutgers.edu/raw/aaa/pi/newsletr/spring99/item07.htm  
I think Briloff was trying to save the profession from what it is now going through in the wake of the Enron scandal.

My Interview With The Baltimore Sun --- http://www.trinity.edu/rjensen/fraudBaltimoreSun.htm 

My Philadelphia Inquirer Interview 1 --- http://www.trinity.edu/rjensen/philadelphia_inquirer.htm 

My Philadelphia Inquirer Interview 2 ---  http://www.trinity.edu/rjensen/FraudPhiladelphiaInquirere022402.htm 

My Interview With National Public Radio --- http://www.trinity.edu/rjensen/fraudNPRfeb7.htm 

Articles on Internal Auditing and Fraud Investigation 
Web Site of Mark R. Simmons, CIA CFE 
http://www.dartmouth.edu/~msimmons/ 

Internal auditing is an independent, objective assurance and consulting activity designed to add value and improve an organization's operations.  It helps an organization accomplish its objectives by bringing a systematic, disciplined approach to evaluate and improve the effectiveness of risk management, control, and governance processes. (Institute of Internal Auditors)

Fraud Investigation consists of the multitude of steps necessary to resolve allegations of fraud - interviewing witnesses, assembling evidence, writing reports, and dealing with prosecutors and the courts. (Association of Certified Fraud Examiners)

This site focuses on topics that deal with Internal Auditing and Fraud Investigation with certain hyper-links to other associated and relevant sources. It is dedicated to sharing information.

Other Shared and Unshared Course Material

You might find some useful material at http://www.indiana.edu/~aisdept/newsletter/current/forensic%20accounting.html

I have two cases and some links to John Howland's course materials at http://www.trinity.edu/rjensen/acct5342/262wp/262case1.htm

You might find some materials of interest at http://www.trinity.edu/rjensen/ecommerce/assurance.htm

Also see http://www.networkcomputing.com/1304/1304ws2.html

Micromash has a bunch of courses, but I don't think they share materials for free --- http://www.cyberu.com/classes.asp

Important Database  --- From the Scout Report on February 1, 2001

LLRX.com: Business Filings Databases http://www.llrx.com/columns/roundup19.htm 

This column from Law Library Resource Xchange (LLRX) (last mentioned in the September 7, 2001 Scout Report) by Kathy Biehl becomes more interesting with every revelation of misleading corporate accounting practices. This is a straightforward listing of state government's efforts to provide easy access to required disclosure filings of businesses within each state. Each entry is clearly annotated, describing services offered and any required fees (most services here are free). The range of information and services varies considerably from very basic (i.e. "name availability") to complete access to corporate filings. The noteworthy exception here is tax filings. Most states do not currently include access to filings with taxing authorities.

IMPORTANT NOTE:
If another district or date than the one for which you searched appears in the "Court" column, the explanation may be that the district/date for which you searched is related to this case but is not singled out as our "First Identified District". This list may be considered inclusive.

From the Stanford Law School Securities Fraud Database --- http://securities.stanford.edu/1022/TTWO01-01/ 

Take-Two Interactive CASE INFORMATION 

Summary: According to a Press Release dated December 21, 2001, the complaint alleges that during the Class Period defendants materially misrepresented Take-Two's financial results and performance for each of the quarters of and full year of fiscal 2000, ended October 31, 2000, and each of the first three quarters of fiscal 2001, ended January 31, 2001, April 30, 2001 and July 31, 2001, respectively, by improperly recognizing revenue on sales to distributors. On August 24, 2001, the truth about the Company's financial condition began to emerge when the effects of defendants' scheme began to negatively impact the Company's financial results. It was not until December 14, 2001 and December 17, 2001, however, that the market began to learn that defendants had caused the Company to improperly recognize revenue for products shipped to distributors, where the distributors did not have a binding commitment to pay for the products, in direct contravention of GAAP. Significantly, defendants' unlawful accounting practices enabled defendants to portray Take-Two as a financially strong company that was experiencing dramatic revenue growth, and which was poised for future success when, in fact, the Company's purported success was the result of improper accounting practices. On December 14, 2001, following rumors of a possible restatement of Take-Two's financial results, Take-Two's common stock fell 31% --$4.72 a share to $10.33 per share. During the Class Period, Take-Two shares traded as high as $24.50 per share. Defendants were motivated to misrepresent the Company's financial results, by among other things, their desire to sell approximately 900,000 shares of Take-Two common stock during the Class Period at artificially inflated prices for proceeds of over $15 million.

INDUSTRY CLASSIFICATION: SIC Code: 7372 Sector: Technology Industry: Software & Programming

NAME OF COMPANY SUED: Take-Two Interactive Software Inc. 

COMPANY TICKER: TTWO COMPANY WEBSITE: http://www.take2games.com 

FIRST IDENTIFIED COMPLAINT IN THE DATABASE Fischbein, et al. v. Take-Two Interactive Software Inc., et al. COURT: S.D. New York DOCKET NUMBER: JUDGE NAME: DATE FILED: 12/18/2001 SOURCE: Business Wires CLASS PERIOD START: 02/24/2000 CLASS PERIOD END: 12/17/2001 TYPE OF COMPLAINT: Unamended/Unconsolidated PLAINTIFF FIRMS IN THIS OR SIMILAR CASE: Milberg Weiss Bershad Hynes & Lerach, LLP (New York, NY) One Pennsylvania Plaza, New York, NY, 10119-1065 (voice) 212.594.5300, (fax) , Rabin & Peckel LLP 275 Madison Avenue, New York, NY, 10016 (voice) 212.682.1818, (fax) , email@rabinlaw.com Schiffrin & Barroway, LLP 3 Bala Plaza E, Bala Cynwyd, PA, 19004 (voice) 610.667.7706, (fax) 610.667.7056, info@sbclasslaw.com 

TOTAL NUMBER OF PLAINTIFF FIRMS: 3

February 28, 2002 message from Allen Plyler

Bob,

Take-Two Interactive just restated their last restatement.

Allen Plyler
Keller Graduate School of Management, Chicago, Illinois.

Important Database --- From the Scout Report on February 1, 2001

LLRX.com: Business Filings Databases http://www.llrx.com/columns/roundup19.htm 

This column from Law Library Resource Xchange (LLRX) (last mentioned in the September 7, 2001 Scout Report) by Kathy Biehl becomes more interesting with every revelation of misleading corporate accounting practices. This is a straightforward listing of state government's efforts to provide easy access to required disclosure filings of businesses within each state. Each entry is clearly annotated, describing services offered and any required fees (most services here are free). The range of information and services varies considerably from very basic (i.e. "name availability") to complete access to corporate filings. The noteworthy exception here is tax filings. Most states do not currently include access to filings with taxing authorities.

I added the above to my evolving monster on accounting and securities fraud at http://www.trinity.edu/rjensen/fraud.htm 

From The Wall Street Journal Accounting Educators' Review on May 23, 2002

TITLE: SEC Broadens Investigation Into Revenue-Boosting Tricks; Fearing Bogus Numbers Are Widespread, Agency Probes Lucent and Others 
REPORTER: Susan Pulliam and Rebecca Blumenstein 
DATE: May 16, 2002 
PAGE: A1 
LINK: http://online.wsj.com/article/0,,SB1021510491566948760.djm,00.html  
TOPICS: Financial Accounting, Financial Statement Analysis

SUMMARY: "Securities and Exchange Commission officials, concerned about an explosion of transactions that falsely created the impression of booming business across many industries, are conducting a sweeping investigation into a host of practices that pump up revenue."

QUESTIONS: 
1.) "Probing revenue promises to be a much broader inquiry than the earlier investigations of Enron and other companies accused of using accounting tricks to boost their profits." What is the difference between inflating profits vs. revenues?

2.) What are the ways in which accounting information is used (both in general and in ways specifically cited in this article)? What are the concerns about using accounting information that has been manipulated to increase revenues? To increase profits?

3.) Describe the specific techniques that may be used to inflate revenues that are enumerated in this article and the related one. Why would a practice of inflating revenues be of particular concern during the ".com boom"?

4.) "[L90 Inc.] L90 lopped $8.3 million, or just over 10%, off revenue previously reported for 2000 and 2001, while booking the $250,000 [net difference in the amount of wire transfers that had been used in one of these transactions] as 'other income' rather than revenue." What is the difference between revenues and other income? Where might these items be found in a multi-step income statement? In a single-step income statement?

5.) What are "vendor allowances"? How might these allowances be used to inflate revenues? Consider the case of Lucent Technologies described in the article. Might their techniques also have been used to boost profits?

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

--- RELATED ARTICLES --- 
TITLE: CMS Energy Admits Questionable Trades Inflated Its Volume 
REPORTER: Chip Cummins and Jonathan Friedland 
PAGE: A1 
ISSUE: May 16, 2002 
LINK: http://online.wsj.com/article/0,,SB1021494984503313400.djm,00.html 

From The Wall Street Journal Accounting Educators' Review on May 27, 2004

TITLE: SEC Gets Tough With Settlement in Lucent Case 
REPORTER: Deborah Solomon and Dennis K. Berman 
DATE: May 17, 2004 
PAGE: A1 
LINK: http://online.wsj.com/article/0,,SB108474447102812763,00.html  
TOPICS: Criminal Procedure, Financial Accounting, Legal Liability, Revenue Recognition, Securities and Exchange Commission, Accounting

SUMMARY: After a lengthy investigation into the accounting practices of Lucent Technologies Inc., the Securities and Exchange Commission is expected to file civil charges and impose a $25 million fine against the company. Questions focus on the role of the SEC in financial reporting.

QUESTIONS: 
1.) What is the Securities and Exchange Commission (SEC)? When was the SEC established? Why was the SEC established? Does the SEC have the responsibility of establishing financial reporting guidelines?

2.) What role does the SEC currently play in the financial reporting process? What power does the SEC have to sanction companies that violate financial reporting guidelines?

3.) What is the difference between a civil and a criminal charge? What is the difference between a class-action suit by investors and a civil charge by the SEC?

4.) What personal liability do individuals have for improper accounting? Why does the SEC object to companies indemnifying individuals for consequences associated with improper accounting?

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

Bob Jensen's threads on revenue accounting are at http://www.trinity.edu/rjensen/ecommerce/eitf01.htm 

Bob Jensen's threads on accounting theory are at http://www.trinity.edu/rjensen//theory/00overview/theory01.htm 

One-time Internet booster Henry Blodget, who recently left Merrill Lynch, is reportedly one of several stock analysts being probed for alleged conflicts of interest --- http://www.wired.com/news/politics/0,1283,48992,00.html 

From The Wall Street Journal's Accounting Educator Reviews on January 24, 2002

TITLE: Ex-Official at Leslie Fay Gets Nine-Year Sentence for Accounting Fraud 
REPORTER: Staff Reporter DATE: Jan 21, 2002 
PAGE: B2 
LINK: http://interactive.wsj.com/archive/retrieve.cgi?id=SB1011571420328020280.djm  
TOPICS: Accounting, Accounting Fraud, Accounting Law, Fraudulent Financial Reporting, Legal Liability, Negligent Misrepresentation

SUMMARY: Paul F. Polishan, the former chief financial officer and senior vice president of Leslie Fay, was convicted of 18 felony counts for his role in overstating the earnings of Leslie Fay between 1989 and 1993. Mr. Polishan was sentenced to serve nine years in prison. Questions deal with accountants' liability and consequences of fraudulent financial reporting.

QUESTIONS: 
1.) In what situations is overstating earnings a crime? What other penalties could result from overstating earnings? Do you think overstating earnings should result in a prison sentence? Support your answer.

2.) Were Leslie Fay's financial statements audited? What responsibility does the auditor bear concerning the earnings overstatement?

3.) In what situations would an independent auditor be liable under common law for overstated earnings? What defenses are available to the auditor?

4.) In what situations would an independent auditor be liable under civil law for overstated earnings? What defenses are available to the auditor?

5.) In what situations would an independent auditor be liable under criminal law for overstated earnings? What defenses are available to the auditor?

6.) Who is harmed by overstated earnings? How are each of these groups harmed?

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

In particular, it has raised awareness of “hollow swaps”, where two telecoms companies exchange identical amounts of network capacity, then book the purchase cost as capital expense and the sale as revenue. Although C&W says it does not use hollow swaps, it has recently admitted to using another controversial accounting method to book the sale of “indefeasible right of use” (IRU) contracts. C&W booked the contracts, which give access to its telecoms network, as upfront revenue even though they were spread over periods of up to 15 years. Such deals — which were outlawed in 1999 by regulators in America — boosted C&W’s revenues by £373 million in 2001.
Chris Ayres and Clive Mathieson, London Times Online, March 1, 2002 --- http://www.thetimes.co.uk/article/0,,5-222235,00.html 

Association of Certified Fraud Examiners --- http://www.cfenet.com/home.asp 

The Association of Certified Fraud Examiners is an international, 25,000-member professional organization dedicated to fighting fraud and white-collar crime. With offices in North America and chapters around the globe, the Association is networked to respond to the needs of anti-fraud professionals everywhere.

In the April 2002 issue of Journal of Accountancy, Joseph Wells, chairman of the Association of Certified Fraud Examiners (CFE), reviews the results of a survey by CFE and discusses the implications for CPAs. http://www.accountingweb.com/item/77418 

In Congressional testimony on February 14, James G. Castellano, the chairman of the American Institute of CPAs said the Institute plans to release a draft of a new standard by the end of February. The objective of the new standard is to help auditors detect new types of management fraud. http://www.accountingweb.com/item/72560 

A message from Andrew Priest on February 34. 2002

Yahoo! is carrying this news story in respect of Tyco International. Apparently the firm spent $US8 billion in its past three fiscal years on more than 700 acquisitions that were never announced to the public. The story is at http://au.news.yahoo.com/020205/2/3vlo.html  .

Is this another Andersen client? :-) Seriously does anyone know who the auditor is on this one?

Thanks 
Andrew Priest

The auditor is PricewaterhouseCoopers (PwC)

SEC News, Regulations, and Litigation Summaries --- http://www.sec.gov/ 

On May 20, 2002 the Securities and Exchange Commission announced proceedings against Big Five firm Ernst & Young. The case reaches back to the years before E&Y's consulting practice was sold to Cap Gemini. It involves alleged independence violations due to product sales and consulting fees related to PeopleSoft software, while PeopleSoft was an E&Y audit client. http://www.accountingweb.com/item/81348 

Update on June 1, 2002 --- http://www.as411.com/AcctSoftware.nsf/00/prDBD2F8AEEF51127686256BEC00167F9F 

In a ruling Tuesday, Brenda Murray, the chief administrative law judge at the SEC, granted Ernst & Young's motion for summary judgment and dismissed the case without prejudice. Ms. Murray agreed with Ernst & Young that more than one SEC commissioner needed to approve the action for it to be valid.

From Double Entries on July 5, 2002

In the first-ever auditor independence case against a foreign audit firm, the Securities and Exchange Commission has brought a settled enforcement action against Moret Ernst & Young Accountants (Moret), a Dutch accounting firm now known as Ernst & Young Accountants. The case arises from Moret's joint business relationships with an audit client. In today's order, the SEC censured Moret for engaging in "improper professional conduct" within the meaning of Rule 102(e) of the SEC's Rules of Practice, and ordered Moret to comply with certain remedial undertakings, including the payment of a $400,000 civil penalty. This is the first time that the SEC has ordered any audit firm to pay a civil penalty for an auditor independence violation. Moret consented to the order without admitting or denying the SEC's findings. Full details from the SEC in our full article. Just click on through

"SEC List of Accounting-Fraud Probes Grows, Stretching Agencies Resources," The Wall Street Journal, July 6, 2001 --- http://interactive.wsj.com/archive/retrieve.cgi?id=SB994366683510250066.djm 

WSJ Interactive Questions on July 12, 2001

1.) "The most visible indicator of improper accounting-and source of new investigations-is the growing number of restated financial reports." Based on your knowledge of APB Opinion 23, why is this statement true? What other sources of information does the SEC use to trigger investigations?

2.) Why would the SEC want to "ferret out" questionable accounting practices before "word of a company's accounting problems has leaked and battered its stock price"? How does this goal relate to the SEC's responsibilities? What steps are they undertaking to accomplish this goal?

3.) What is fraudulent financial reporting (as opposed to an accounting error)? Why might the current economic circumstances lead to greater incidences of fraudulent financial reporting?

4.) Read the summary of a research study entitled "Fraudulent Financial Reporting: 1987-1997: An Analysis of U.S. Public Companies" at the AICPA web site http://www.aicpa.org/news/p032699b.htm  How do the factors identified in this study provide a basis for helping the SEC to detect questionable accounting practices earlier than is now the norm?

5.) How are executives' compensation packages tied to share prices? What are the benefits of such compensation arrangements? Why do current market conditions enhance the risk that executives may be willing to undertake earnings management practices to enhance their own salaries? What market reactions to earnings announcements exacerbate these incentives to manage earnings?

American Institute of Certified Public Accountants --- http://www.aicpa.org/index.htm 
There are many articles on fraud in the back issues of the Journal of Accountancy --- http://www.aicpa.org/pubs/jofa/joahome.htm 

AICPA Issues Proposed Standard On Fraud Detection
On February 28, 2002, the American Institute of CPAs (AICPA) released a draft of a revised audit standard on Consideration of Fraud in a Financial Statement Audit. If adopted, this updated standard will replace the current standard with the same name, (Statement on Auditing Standards No. 82). http://www.accountingweb.com/item/73718 

From the Journal of Accountancy in July 2002 --- http://www.aicpa.org/pubs/jofa/jul2002/index.htm

Risk Management/Internal Audit
BEYOND TRADITIONAL AUDIT TECHNIQUES
Paul E. Lindow and Jill D. Race
Instead of just reviewing required controls, internal auditors can broaden their approach both within and outside the audit process to identify areas for risk management improvements. Here’s a case study on how the internal audit group at California Federal Bank redefined its role to add more value and become key advisers to the company.

Risk Management/Litigation Services
FIVE TIPS TO STEER CLEAR OF THE COURTHOUSE
Paul Sweeney
As litigation costs continue to mount, businesses want to develop efficient strategies to identify and monitor vulnerabilities and avoid lawsuits. CPAs have the expertise to offer clients solutions to several corporate risk management problems.

From The Wall Street Journal Accounting Educators' Review on March 7, 2002

TITLE: Auditing Standard for Detecting Fraud Is Posed
REPORTER: Dow Jones Newswires
DATE: Mar 01, 200
PAGE: A4
LINK: http://online.wsj.com/article/0,,BT_CO_20020228_009080.djm,00.html
TOPICS: Auditing

SUMMARY: The article implies that a new auditing standard on fraud actually has been issued, but the actual document issued was an exposure draft of a proposed standard.

QUESTIONS:

1.) Access the AICPA web site to read the actual document issued by the Auditing Standards Board at http://www.aicpa.org/members/div/auditstd/consideration_of_fraud.htm 

The article begins with the statement that "the Auditing Standards Board (ASB) of the American Institute of Certified Public Accountants issued expanded fraud guidance for U.S. auditors..."  Is this statement correct?

2.) In the second paragraph of the article, the author states, "The guidance comes at a time when questionable accounting practices have surfaced in the wake of bankruptcy-law filings by...Enron Corp. and Global Crossing Ltd."  Were these recent scandals the reason behind the new auditing standard proposal?  If not, what were the ASB's reasons for proposing the new standard?  (Hint:  again see the actual document at the AICPA's web site.)

3.) The proposed new standard would mandate specific requirements to search for fictitious entries and perform other tests to search for fraud under certain circumstances.  Compare and contrast this proposal to current auditing requirements to search for fraud.

SMALL GROUP ASSIGNMENT: The proposed auditing standard requests feedback from respondents to assess each of the major areas of the new standard  (e.g., classification of risk factors for fraud, identification of revenue recognition as the major area for risk of fraud, consideration of the risk of management override of fraud, inquiry of audit committees about fraud, and the attitude of professional skepticism).  Divide the class into small groups and assign one section to each group to draft a response to the questions posed in the exposure draft.

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

Institute of Internal Auditors (IIA) --- http://www.theiia.org/ 

Can Internal Auditors truly be independent while being employed by the entity and seen as working for the management to achieve organizational goals? In theory, External Auditors are more likely to be perceived as independent, but is it not the case that Internal Auditors appear to have little or no independence? http://www.accountingweb.com/item/65704 

Articles on Internal Auditing and Fraud Investigation 
Web Site of Mark R. Simmons, CIA CFE 
http://www.dartmouth.edu/~msimmons/ 

Internal auditing is an independent, objective assurance and consulting activity designed to add value and improve an organization's operations.  It helps an organization accomplish its objectives by bringing a systematic, disciplined approach to evaluate and improve the effectiveness of risk management, control, and governance processes. (Institute of Internal Auditors)

Fraud Investigation consists of the multitude of steps necessary to resolve allegations of fraud - interviewing witnesses, assembling evidence, writing reports, and dealing with prosecutors and the courts. (Association of Certified Fraud Examiners)

This site focuses on topics that deal with Internal Auditing and Fraud Investigation with certain hyper-links to other associated and relevant sources. It is dedicated to sharing information.

Certified Forensic Investigators in Canada --- FAQs --- http://www.homewoodave.com/frequently%20asked%20question.htm 

"Regulators Check the New Economy's Books," by Karl Schoenberger, The New York Times, August 19, 2001 --- http://college2.nytimes.com/guests/articles/2001/08/19/864842.xml 

Responding to widespread concerns that investors were not always given reliable financial information in that time of frantic revenue growth, regional offices of the S.E.C., the Federal Bureau of Investigation and the United States attorney's office here are cooperating in a legal crackdown on accounting violations.

A tough law-enforcement response to accounting irregularities, of course, is not new. In the past year, federal investigators have pursued cases of irregularities at companies like Waste Management (news/quote), Cendant (news/quote) and Sunbeam. But now the government is turning up the heat in Silicon Valley, home to a preponderance of questionable accounting, particularly among software companies, during the Internet boom.

Over the last four years, nearly one in five accounting restatements — red flags for potential misconduct — have been by companies in California, according to a study by Arthur Andersen, the accounting firm. (Arthur Andersen was itself the recent subject of an S.E.C. civil sanction for the way it audited the books of Waste Management, the trash-disposal company, and agreed to a settlement without admitting or denying civil fraud allegations.) In the same four- year period, the total number of restatements for all industries has nearly doubled, Arthur Andersen's report said.

So far in the technology sector, federal investigators and prosecutors here have set their sights on relatively small companies, where a high proportion of problems center on what accountants call improper "revenue recognition" — the recording of revenue that does not exist. It could be, for example, from a pending sale that is misclassified as completed, or a service contract in which money has not yet changed hands.

The Arthur Andersen study of accounting restatements from 1997 to 2000 showed that 27 percent of the restatements nationwide had been filed in the software and computer industries. About 62 percent of the software companies involved had annual gross revenue of less than $100 million.

The rise of accounting fraud investigations, specifically related to overstatement of revenue, reflects a serious white-collar crime trend in the high-technology sector in recent years, said Leslie B. Caldwell, chief of the securities fraud section for the United States attorney's office here.

"The pressure to do this in the technology industry was intense because the expectation for growth was so high, and it wasn't sustainable," she said, without commenting on specific cases.

The inquiry at Indus International focused on revenue for the third quarter of 1999. According to the shareholder lawsuits against the company and former executives, the revenue total included sales derived from "irregular contracts," money that was not received during the quarter in question. Last October, Indus International agreed to settle the suits for $4.3 million without admitting or denying wrongdoing.

Previously, Ms. Caldwell said, her office waited for the S.E.C. to refer cases for criminal investigation. But now, "we're taking the bull in our own hands," she said.

"There are a number of matters under investigation of corporations that cooked their books to meet Wall Street's expectations — expectations that the companies themselves created," she added.

Harris Miller, president of the Information Technology Association of America, a trade group, said accounting problems in the software industry had arisen because of what he called vague rules covering sales of licensing agreements, which resulted in many companies claiming revenue that they expected to receive.

"The rules for revenue recognition were a bit cloudy, not just for software companies but for any company that delivers services over time," Mr. Miller said. His organization, he said, was not making excuses for executives who intentionally violated regulations. "Yes, there was pressure to drive the top line," he said. "But you can never justify misconduct."

Ms. Caldwell's unit of seven lawyers, responsible for expediting complicated and paper-intensive securities investigations, was created in February 2000 by Robert S. Mueller, United States attorney for the Northern District of California, whom President Bush chose to serve as director of the F.B.I.

Matthew J. Jacobs, a spokesman for the United States attorney's office here, said Mr. Mueller had made the prosecution of accounting fraud a major objective because of its prevalence in both economic booms and declines. Mr. Mueller was not available for comment, the United States attorney's office said on Friday.

In its most prominent case to date, Ms. Caldwell's team obtained indictments last September against two former executives at McKesson, the pharmaceutical and medical technology company based here. The defendants were charged with accounting fraud related to the 1999 merger of McKesson and HBO & Company, a software company based in Atlanta. Prosecutors said $9 billion in shareholder losses resulted. The defendants pleaded not guilty to the charges, and the case is in the pretrial phase.

 

The F.B.I. and federal prosecutors here are investigating about 50 cases of possible criminal securities fraud in the district, more than a dozen of them focusing on companies suspected of accounting fraud.

In addition to Indus International, at least six small and medium-size software companies in Northern California are under federal criminal and civil investigation, according to officials. Among them is Critical Path, a San Francisco company that sells e-mail messaging technology to other businesses and reported $135.7 million in sales last year. In February, after an internal investigation that led to the departure of its chief executive and two other executives, Critical Path restated revenue for the third and fourth quarters of 2000, subtracting a total of $19.4 million from what it had claimed. The company's share price plummeted and class-action suits were filed, contending deception and fraud. Critical Path has said it is cooperating with investigators.

In another case, the S.E.C. filed a civil complaint last September in Federal District Court here against three former executives of the Cylink Corporation (news/quote), a Santa Clara company that makes cryptographic software for computer network security, accusing them of violating accounting rules by recognizing spurious transactions as sales in quarterly earnings statements. The complaint said Cylink recognized more than $900,000 in revenue in the second quarter of fiscal 1998 for sales in which some customers were given a three-month window to cancel their orders.

"When senior officers are involved in this kind of conduct we're going to hold them responsible," Robert L. Mitchell, head of the S.E.C.'s enforcement office in San Francisco, said when the complaint was issued. "Companies only act through individuals." The S.E.C. settled a separate administrative "cease and desist" proceeding with the corporation. In the civil litigation against three former Cylink executives, each was accused of securities fraud, circumvention of Cylink's internal controls and falsification of records.

In July, according to court records, one of the former Cylink executives, Thomas Butler, who had been vice president for sales, signed a consent decree, without admitting or denying the charges, agreeing to pay a $100,000 fine and forfeit a $25,000 bonus he had been awarded by Cylink for his sales performance. Litigation against the two other defendants is still pending. Robert Fougner, Cylink's general counsel, said that he and other company executives could not comment on the case.

In cases in which criminal charges are brought against company executives, potential penalties can be harsh. In addition to fines imposed by the S.E.C., a conviction of an executive on a criminal securities fraud charge can result in a prison sentence of up to 10 years and a fine as high as $1 million. Conviction on a lesser charge, like wire fraud or conspiracy, carries a maximum five- year sentence and $250,000 fine.

Until recently, the pace of these investigations had been plodding, owing to their complexity and a shortage of resources. For example, Scorpion Technologies, a software company that was based in Los Gatos, Calif., and is now defunct, was accused of fraudulently claiming as much as $3.6 million of its $12.4 million in reported 1991 revenue. The S.E.C. filed civil charges and federal prosecutors indicted company executives on securities fraud charges in 1996. The last of the Scorpion defendants, John T. Dawson, was indicted in 1999. Last November, he pleaded guilty to charges that he had helped create offshore companies that masqueraded as buyers of Scorpion software products. Mr. Dawson's sentencing hearing is set for Oct. 2.

The Justice Department has a high threshold for criminal prosecution in these cases, with a distinction being made between misleading accounting practices and criminal fraud, Ms. Caldwell said. A suspicious accounting trick, by itself, cannot be the basis for seeking an indictment without other facts establishing deliberate fraud, she said.

Some major technology companies, including Lucent Technologies (news/quote), have been subject to recent class- action suits contending irregularities in the way the companies accounted for their growing revenue before their businesses weakened. The S.E.C. started examining Lucent's books last November, after the company had disclosed an accounting problem, fired an employee and filed a restatement lowering its revenue for its fiscal year 2000 by $679 million.

Lucent, however, seems an exception. For now, at least, it appears to be the smaller technology companies that are receiving the most scrutiny.

Continued at  http://college2.nytimes.com/guests/articles/2001/08/19/864842.xml  

The Securities and Exchange Commission has filed suit against the founder and five other former top officers of Waste Management Inc. for massive fraud. The complaint charges the defendants with inflating profits to meet earnings targets. http://www.accountingweb.com/item/76329 

Note that Waste Management just announced that it was changing auditors.  The auditor up to now was (guess?) Arthur Andersen.

"Channel stuffing" refers to the practice of building inventories in distribution channels. On July 11, 2002 Bristol-Myers Squibb, one of the world's largest pharmaceutical companies, confirmed that the Securities and Exchange Commission (SEC) has launched an "informal inquiry" into its sales practices. http://www.accountingweb.com/item/85930 

Channel stuffing was (is?) common in the tobacco industry where companies load up sales revenues on deliveries that they know they will have to take back after the freshness dates on packages expire.  More cartons were (are?) sent to customers than can ever be sold before expiration dates.

You can read about more revenue reporting tricks at http://www.trinity.edu/rjensen/ecommerce/eitf01.htm 

Lurking in the shadows behind the public spotlight on Andersen and Enron has been a criminal case against BDO Seidman for failing to report that a client had misappropriated investor funds. Legal steps this week follow a settlement in April with a goal of removing all criminal charges against the firm. http://www.accountingweb.com/item/84264/ee2eE47/3825 

BDO Seidman snags guilty verdict
National CPA firm BDO Seidman LLP has been found grossly negligent by a Florida jury for failing to find fraud in an audit that resulted in costing a Portuguese Bank $170 million. The verdict opens up the opportunity for the bank to pursue punitive damages that could exceed $500 million.
"BDO Seidman snags guilty verdict," AccountingWeb, June 26, 2007 ---
http://www.accountingweb.com/cgi-bin/item.cgi?id=103667

Bob Jensen's fraud updates are at
http://www.accountingweb.com/cgi-bin/item.cgi?id=103667

PricewaterhouseCoopers accused of lax audits of Gazprom

Welcome to the first issue of BusinessWeek Online's European Insider. This weekly newsletter contains highlights of news, analysis, commentary, and regular columns that cover Europe specifically, as well as other stories with wide international impact.

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EUROPEAN BUSINESS

Gazprom: Russia's Enron?

Angry investors are accusing PricewaterhouseCoopers of lax audits of Gazprom. Did the accounting firm ignore the energy giant's insider dealing and shady asset transfers?

http://www.businessweek.com/magazine/content/02_07/b3770079.htm?c=bweuropefeb13&n=link1&t=email 

NEWS ANALYSIS

Can UBS Tame Enron's Wild Traders?

That's the key question facing the Swiss bank as it prepares to take over the Texas company's energy-trading business

http://www.businessweek.com/bwdaily/dnflash/feb2002/nf2002026_4221.htm?c=bweuropefeb13&n=link2&t=email 

"Economic slowdown brings rise in accounting trickery," by Rachel Beck, The Detroit News, August 18, 2001 --- http://detnews.com/2001/business/0108/20/business-272230.htm 

There are growing concerns that the nation's economic downturn is compelling companies to aggressively seek out ways to make their financial statements look better than they really are.

 Just this year, dozens of companies have been caught in the act. Among them:

   -- Xerox Corp. restated earnings after admitting that it did not properly follow certain accounting rules at a Mexican division.
   -- ConAgra Foods Inc. reduced earnings by more than $100 million after discovering fictitious sales and earnings at one of its subsidiaries.
   -- Kroger Co., the giant supermarket chain, revised down its earnings for 1998-2000, saying executives at its Ralphs Grocery subsidiary conspired to hide cash from auditors and senior management.

Accounting manipulation has become so prevalent that lawmakers in Washington are considering hearings on the issue, while the Securities and Exchange Commission has seen a sharp rise in the number of companies under investigation.

 "There is a big question looming out there: Why is there such a massive deterioration in accounting practices and can it be stopped?" said Joseph Carcello, an accounting professor at the University of Tennessee.

Last year there were 156 financial restatements, up from 150 in 1999 and 91 in 1998. The restatements in the last three years add up to more than the combined total for the previous eight years, according to the Financial Executives International, a Morristown, N.J.-based group representing senior corporate financial officers.

About $31.2 billion in market value was wiped out following restatements, as investors sold stock in such companies, according to FEI.

Many companies claim restatements don't mean they have broken any rules, saying that accounting standards are open to interpretation. Often courts are left to decide whether laws were violated.  Most problems stem from how revenue is counted. Corporations can falsely boost sales figures by recording revenue before delivering products or asking customers to receive goods before they need them. Sometimes they will claim sales before the goods are sold at all.

"There is not a "one-shoe-fits-all" mentality that works in accounting," said Mary Ellen Carter, assistant professor of accounting at Columbia University's Graduate School of Business. "Management is in the best position to know what accounting choices capture their business ... but they also know what accounting choices don't."

Companies hire outside auditors to verify their financial statements, mainly to check if accounting standards are met. Yet accounting firms are known to overlook irregularities, sometimes in an attempt to hold on to their audit contracts and more lucrative consulting services for the same companies.

In June, accounting titan Arthur Andersen LLP agreed to pay a $7 million civil fine to settle federal allegations that it issued false and misleading audit reports for Waste Management Inc. from 1993 to 1996 that inflated the trash hauler's profits by more than $1 billion. Andersen neither acknowledged nor denied the allegations.

"There is supposed to be checks in the system that prevent management from being able to do such things, but it is clear that the checks have eroded," said Michael Lange, a partner in Berman DeValerio Pease Tabacco Burt & Pucillo, a Boston law firm that handles investor lawsuits.  At Centennial Technologies, top executives fabricated sales of "Flash 98," a nonexistent product, to friends of former CEO Emmanuel Pinez. The company also created false sales records by shipping fruit baskets to Pinez' friends and recording the shipments as $2 million in revenues.   The maneuvers made it look like Centennial made a profit of $12 million in 1996, when in reality the company lost $28 million.  Based on the earnings reports, shares of Centennial increased 450 percent in 1996 to $55.50 a share. Faraone managed to get in at $46 a share, but after the fraud was uncovered in early 1997, the stock plunged to $3.

Last year, Pinez was convicted in federal court, and sentenced to five years in prison and a $150 million fine.  Other companies -- blue-chips and startups -- have employed similar schemes.  Sunbeam Corp. and its former CEO Albert Dunlap are accused of creating the illusion of a speedy turnaround after he arrived at the company in 1996. An SEC lawsuit filed in May alleges that the company shifted revenues to inflate losses under the old management and added the sales back to inflate income under Dunlap.  The lawsuit also charges that Sunbeam offered discounts to customers that stocked up on merchandise months ahead of schedule, but failed to disclose that such revenue would hurt future results. Dunlap has denied the allegations.

Xerox, the troubled business machine maker, restated earnings from 1998 to 2000 in May after acknowledging that its Mexican subsidiary improperly booked sales and hid bad debts. Questions over its accounting practices helped push its stock down more than 60 percent in the last year.

ConAgra, whose brands include Bumble Bee tuna and Butterball turkeys, said in May that falsified sales at its United Agri Products Cos. subsidiary would force it to lower earnings from 1998 to 2000 by about $123 million. The company and the SEC are informally investigating the accounting practices.

Last month, software maker AremisSoft Corp. announced it was cooperating with a SEC probe into unaccounted-for revenues. The company claimed $7.1 million in sales to the Bulgarian government last year, but auditors have confirmed receipt of only $1.7 million.

The SEC has become increasingly aggressive in its crackdown against alleged offenders. About 260 investigations now under way, a substantial jump from years past.  Lawmakers are also expressing concern about accounting fraud. Rep. Richard Baker, R-La., chairman of a House subcommittee on capital markets, said last month that he may call hearings on the issue.  There's also been a rise in the number of shareholder lawsuits. A recent study by the audit and consulting firm PricewaterhouseCoopers found that of the 201 class-action federal and state lawsuits filed against corporations in 2000, some 53 percent contained accounting allegations. That's up from less than 40 percent in 1995.

"The spectrum of lawsuits goes across all industries, and all sizes of business" said Harvey Kelly, partner in the corporate investigations practice at PricewaterhouseCoopers. "It shows that no one is immune to these kind of challenges."  Faraone joined a class-action lawsuit against Centennial, never expecting to see any of his losses returned. A settlement of the case in 1998 got him 666 shares back, then valued at about 50 cents each, and he sold them immediately.  The company, however, was bought this year by Solectron Corp. for $108 million. Centennial stockholders collected $13.79 for every share they owned. If Faraone had waited, he could have recovered nearly $9,200.  He, however, has no regrets about selling the stock.

"This company did me wrong in a sneaky way," he said. "I wasn't willing to take any more chances."

Big 4 Securities Class Action Litigation- Citing Auditor as Defendants --- http://www.trinity.edu/rjensen/AuditingFirmLitigationNov2006.pdf

Soul Searching at E&Y
Certainly, the accounting profession, our firm included, has taken some shots from regulators and others over the last several years, and I'm here to tell you that we deserved some of those shots. I do feel somewhat fortunate, though, that my profession has faced some very tough times, and not only survived, but emerged better for the experience. The times have taught us the dangers of being arrogant...of not listening. We have been reminded of the importance of engaging with others, not just with companies and boards, but with policymakers, opinion leaders, academicians, and the investor community. While what we have been through has been difficult, it has been to a positive end because it has encouraged us to do some soul-searching--as individuals and as a profession--to rediscover our roots. We have had time to ask ourselves, as accounting professionals, why we do what we do...why it matters. What is our purpose and how does that guide our decisions? These are important questions in defining the culture of any organization.
Jim Turley, CEO of Ernst & Young, December 1, 2005 ---
http://eyaprimo.ey.com/natlmktgaprimoey/Attachments/Attachment42550.pdf
 

Google Officer and Ernst & Young Settle with the SEC
Google’s chief legal officer and Ernst & Young’s Irish branch have settled claims that they let the executive’s former employer, SkillSoft, overstate profits, the Securities and Exchange Commission said yesterday.
The New York Times, July 20, 2007 ---
http://www.nytimes.com/2007/07/20/business/20skillsoft.html?_r=1&oref=slogin
 

The Accounting Firm Ernst & Young Dodges a Bullet (well sort of anyway)
Four current and former partners of the accounting firm Ernst & Young have been charged with tax fraud conspiracy over their work on questionable tax shelters. The firm itself was not charged. But the indictment against the four, which was announced yesterday, did not mean that Ernst & Young, which has been under investigation since 2004, was entirely off the hook in a widening criminal investigation of the web of banks, accounting firms, law firms and investment boutiques that promoted questionable shelters.
Lynnley Browning, "Four Men, but Not Ernst & Young, Are Charged in Tax Shelter Case," The New York Times, May 31, 2007 --- http://www.nytimes.com/2007/05/31/business/31shelter.html?ref=business  

"E&Y partners indicted for tax fraud" AccountingWeb, May 31, 2007 ---
http://www.accountingweb.com/cgi-bin/item.cgi?id=103562

The firm of KPMG to date has taken a much, much heavier hit for selling questionable tax shelters --- http://www.trinity.edu/rjensen/Fraud001.htm#KPMG

Equitable trial: E&Y fights for its future
In one of the biggest court cases in British accounting history, Ernst & Young battles it out with life assurance firm, Equitable Life, at London's High Court. At stake? The future of the Big Four firm. Equitable Life's £2bn lawsuit against Ernst & Young, its former auditors, kicked off on Monday 11 April, 2005. Equitable is suing E&Y for alleged negligence in the overseeing of its accounts in the late 1990s. As well as explaining their cases in court, both parties submitted written explanations of their case. Here, you can read Equitable's claim against the Big Four firm, and E&Y's furious response.
"Equitable trial: E&Y fights for its future," Financial Director, April 26, 2005 --- http://www.financialdirector.co.uk/specials/1140053

September 26, 2005 message from David Albrecht [albrecht@PROFALBRECHT.COM]

The Equitable Life law suit against Ernst &Young has been dismissed. This multi-billion dollar suit originally had the potential to wipe out E&Y UK. Some columnists speculated that it ahd the potential to bring down E&Y worldwide.

"Equitable's claim against Ernst & Young was centered on the accountant's alleged failure to inform the then board about the extent of the mutual's financial problems.

However, Equitable decided to abandon the case after lawyers pointed out there was a good chance the former directors would not have acted differently had Ernst & Young given different advice."

http://business.timesonline.co.uk/article/0,,9557-1795562,00.html

The California Board of Accountancy has taken disciplinary action against Big Four firm Ernst & Young LLP because of independence questions that arose from the firm's dealings with PeopleSoft Inc. In a related event, the New Mexico board voted 4-0 to issue notice that it "contemplated action" against E&Y for its PeopleSoft audits. 
AccountingWeb, September 23, 2004 --- http://www.accountingweb.com/item/99798 

"Former Ernst & Young Clients Sue Over Tax Shelters," AccountingWeb, April 12, 2006 --- http://www.accountingweb.com/cgi-bin/item.cgi?id=102027

Tax Whistleblower 7623:  More Trouble for Ernst & Young Tax Shelter Clients
The Ferraro Law Firm has submitted the first known $1 billion Tax Whistleblower submission to the newly created IRS Whistleblower Office. The IRS specifically created the Whistleblower Office to assist in identifying and capturing uncollected tax revenue from individuals and corporations typically assisted by clever law firms, accounting firms and banks. Tax whistleblower cases under section 7623 are a new arrow in the Commissioner's quiver to close the tax gap, which the GAO estimates to be approximately $345 billion each year. The submission involves a Fortune 500 company that entered into a series of transactions to improperly reduce its taxes by over $1 billion. The company was represented by Ernst & Young LLP, an established law firm and multiple name-brand banks. The identity of the whistleblower is strictly confidential to protect the individual and the identities of the law firm, banks and company are confidential at this stage to aid in the evaluation of the submission. This submission comes after an E&Y employee pled guilty to one count of conspiracy to commit tax fraud, and four E&Y tax partners have been indicted for their role in the sale of fraudulent tax shelters. "The tax law is not always black and white and taxpayers are all too often more than willing to use an extreme interpretation that drastically reduces taxes. There is not necessarily an element of fraud and people at these companies know the weak spots in their positions," said founding partner, James L. Ferraro. Given the recent modifications made to section 7623 of the Internal Revenue Code, the potential award in this case could exceed $300 million.
Accounting Education, October 25, 2007 --- http://accountingeducation.com/index.cfm?page=newsdetails&id=145675

Bob Jensen's threads on whistle blowing are at http://www.trinity.edu/rjensen/FraudConclusion.htm#WhistleBlowing

Bob Jensen's threads on Ernst & Young are at http://www.trinity.edu/rjensen/Fraud001.htm#Ernst

"PCAOB: Ernst & Young Signed Without Evidence," AccountingWeb, May 3, 2007 ---
http://www.accountingweb.com/cgi-bin/item.cgi?id=103472

A report issued by the Public Company Accounting Oversight Board states that Ernst & Young LLP appears to have signed off on some public-company audits without having sufficient evidence to support its opinion. The Associated Press reported that Ernst & Young defended its work while acknowledging that it agreed, in response to the findings, to perform additional procedures for some clients.

"In no instance did these actions change our original audit conclusions or affect our reports on the issuers' financial statements," Ernst & Young said in an April 5 letter to the oversight board that was included in the report.

The latest inspection findings found fault with eight public-company audits by Ernst & Young, down from 10 deficient audits identified in the recently issued 2005 inspection report. By law, the largest audit firms must undergo annual inspection by the oversight body, created by Congress in 2002 to inspect and discipline public company accountants.

Inspection findings provide limited insight into audit quality since they don't identify audit clients by name. In response to complaints that the oversight board has been slow to issue findings, board chairman Mark Olson pledged last year to pick up the pace.

"Timeliness of inspection reports continues to be a priority for me, and I am pleased by our progress," Olson said in a statement Wednesday.

According to the 2006 inspection report, Ernst & Young didn't identify one client's departure from generally accepted accounting principles with regard to lease abandonment liability. The report also faulted the auditor's handling of the client's self-insurance reserve and severance payments to former executives. Ernst said it supplemented its work papers and performed additional procedures but that its additional work didn't affect its original conclusions on the unidentified client's financial statement.

Inspectors flagged a second audit where unrecorded audit differences would have reduced net income by as much as 5 percent, saying Ernst & Young failed to consider "quantitative or qualitative factors" relevant to the aggregate uncorrected audit differences. Ernst & Young attributed the difference to a prior-year error identified by its audit team, which it said the client firm corrected in its current year results. While Ernst & Young said it supplemented its 2005 audit record and informed the client's audit committee of the audit differences, it said the actions didn't change its original audit conclusions or affect its report on the firm's financial statements.

The audit firm had the same response to findings on a third audit, one where inspectors took issue with its handling of a long-term licensing agreement paid for partly with cash and partly with stock that would vest in the future. The audit firm disputed findings that there was no evidence it had analyzed the terms of the licensing agreement to ensure it complied with relevant accounting rules.

In a fourth audit, the oversight board's inspectors questioned whether Ernst & Young should have allowed the audit client to aggregate business lines when evaluating impairment of goodwill, saying certain factors indicated that aggregation wasn't appropriate. It said there was no evidence in the audit papers and "no persuasive other evidence" that Ernst & Young considered those factors in reaching its conclusion. For its part, Ernst & Young said it believes the issue was "properly evaluated" and that it took no further action as a result.

Bob Jensen's threads on audit firm professionalism are at http://www.trinity.edu/rjensen/Fraud001.htm#Professionalism

From The Wall Street Journal Accounting Weekly Review on March 30, 2007

Bob Jensen's threads on audit firm professionalism and independence are at
http://www.trinity.edu/rjensen/fraud001.htm#Professionalism

Judge Approves $36M Settlement Balance in PNC Accounting Scandal: $193 Million Out of $1.15 Billion
The separate suit against Ernst & Young is still pending
A federal judge in Pittsburgh has approved the last part of a settlement involving more than 73,000 shareholders who lost money in a PNC Financial Services Group Inc. accounting scandal. The shareholders are ready to receive about $2,600 each, for a total of $36.6 million, based on the $193 million settlement and interest. That amounts to 68 cents per share, the Pittsburgh Tribune-Review reported. It's not clear when settlement money will be distributed, and the final amount will be reduced by attorneys' fees. The last remaining portion of the class-action lawsuit was approved by U.S. District Judge David S. Cercone, July 13.
"Judge Approves $36M Settlement Balance in PNC Scandal," AccountingWeb, July 19, 2006 ---
http://www.accountingweb.com/cgi-bin/item.cgi?id=102357

Earnings were restated, as required by the Federal Reserve, and the results were $155 million less than originally reported. The lawsuit contends that stockholders who bought the bloated shares between July 19, 2001, and July 18, 2002, lost an estimated $1.15 billion.

PNC paid $25 million to the U.S. Department of Justice to settle conspiracy to commit securities fraud charges in June 2003. The government ordered PNC to place $90 million into the $193 million restitution fund. Most of the rest of the escrow fund came from insurance companies and from AIG, which paid in $44 million.

A separate shareholder lawsuit is pending against Ernst & Young, which reviewed the questionable loan sales.

Continued in article

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

Just a Typical Day on the Fraud Beat
A Houston investment fund, which started as a promising money- maker for a group of wealthy, well-connected acquaintances, has ended in a Texas district court with accounting firm KPMG on the hot seat. http://www.accountingweb.com/item/100455 February 3, 2005

Well, Not Quite Typical to This Extreme
Former E&Y Audit Partner Jailed for SOX Violations
Late last year, Thomas Trauger (Ernst & Young) pled guilty to falsifying records in a federal investigation in violation of the Sarbanes-Oxley Act. He admitted as part of this plea that he knowingly altered, destroyed and falsified records with the intent to impede and obstruct an investigation by the Securities and Exchange Commission. http://www.accountingweb.com/item/100445 

Biovail Corp. said the U.S. Securities and Exchange Commission has launched a formal investigation of the Canadian pharmaceutical company's accounting and financial-disclosure practices, upgrading the regulator's informal inquiry started in late 2003.  This company has so many warts," including complex accounting and poor disclosure in recent years and a business model that focuses heavily on one product, depression treatment Wellbutrin XL, said Anthony Scilipoti, executive vice president of Toronto-based Veritas Investment Research. Reports by Mr. Scilipoti and others have in the past criticized Biovail for focusing on earnings excluding various items, capitalizing costs related to acquired products not yet approved for sale, and hard-to-follow acquisitions and product transactions.
Mark Heinzl, "SEC Begins Formal Accounting Probe of Biovail," The Wall Street Journal, March 7, 2005 --- http://online.wsj.com/article/0,,SB111014883344371591,00.html?mod=todays_us_marketplace 
The independent auditor for Biovail is Ernst & Young.

Difficult times for auditors to claim financial statement audits should not uncover massive fraud
HealthSouth Corp. has filed suit accusing its former outside auditor, Ernst & Young, of intentionally or negligently failing to uncover a massive accounting fraud at the medical services chain.
"HealthSouth Sues Ernst & Young for Fraud," SmartPros, April 6, 2005 --- http://accounting.smartpros.com/x47712.xml
Bob Jensen's threads on E&Y's legal woes are at http://www.trinity.edu/rjensen/fraud001.htm#Ernst

White collar crime still is punished lightly

"Ex-Finance Chief At HealthSouth Gets 5 Years in Jail," by Chad Terhune, The Wall Street Journal, December 10, 2005; Page A3 --- http://online.wsj.com/article/SB113415352157818617.html?mod=todays_us_page_one

A federal judge in Birmingham, Ala., sentenced former HealthSouth Corp. finance chief William T. Owens, the star witness against company founder Richard Scrushy at his criminal trial, to five years in prison.

U.S. District Judge Sharon Blackburn expressed reservations at sending Mr. Owens, 47 years old, to prison, saying she believed Mr. Scrushy directed the $2.7 billion accounting fraud at the health-care company. Mr. Scrushy's trial ended in acquittal in June.

Friday, the judge called it a "travesty" that Mr. Scrushy wouldn't spend any time in prison in connection with the scheme. Mr. Scrushy and his lawyers have repeatedly denied participating in the fraud, claiming that Mr. Owens was the mastermind of the plan and hid it from Mr. Scrushy. In a statement, Mr. Scrushy said Judge Blackburn's comments were "totally inappropriate given that there was not one shred of evidence or credible testimony linking me to the fraud."

Frederick Helmsing, the lawyer for Mr. Owens, had sought probation, in light of Mr. Owens's extensive cooperation with the government investigation since 2003. Prosecutors requested an eight-year prison term.

Continued in article

Bob Jensen's threads on light punishment of white collar crime are at http://www.trinity.edu/rjensen/FraudConclusion.htm#CrimePays
 

Finding the auditors in the wreckage of a crashed airline
“The jury is going to hear a tale of a very strange, intimate relationship" between Tower and Ernst & Young, said attorney Robert Weltchek of Weiner & Weltchek, arguing on behalf of the creditors in a hearing last week. An Ernst & Young spokesman said, "These charges have no merit, and we will vigorously defend ourselves in court."  Court papers say that Ernst & Young's accounting failures led Tower Air to report a pretax profit of $4.6 million in 1998, when it actually lost about $17 million. And Tower Air's reported $3.9 million loss in 1997 was actually at least $41 million larger, the suit states. It goes on to say that the firm never reconciled Tower Air's payroll account, failed to disclose that Tower Air owed $9 million in back excise taxes, and failed to book $2.75 million of travel agents' commissions as an expense.  Ernst & Young became the airline's independent auditor in 1993. The airline was founded 10 years earlier to fly international routes for government and military officers, but went public in 1993. Ernst & Young had done accounting work for the firm and president Morris Nachtomi since the airline's inception and performed lucrative financial advisory work for the firm since the late 1990s, the suit says.
"Bankrupt Airline Sues Ernst & Young for Accounting Fraud," AccountingWeb, March 16, 2005 --- http://www.accountingweb.com/cgi-bin/item.cgi?id=100673 
You can read more about the legal woes of Ernst & Young at http://www.trinity.edu/rjensen/fraud001.htm#Ernst 

Bad audits are so common that multimillion settlements don't even make the front section, let alone the front page.
"Ernst Pays $84 Million to Settle Suit Filed in 1993 by Bank Trustee," by Jonathan Weil and Diya Gullapalli, The Wall Street Journal, January 27, 2005, Page C3 --- http://online.wsj.com/article/0,,SB110679689916037687,00.html?mod=todays_us_money_and_investing 

Ernst & Young LLP agreed to pay $84 million to settle a lawsuit in Boston over its audit work more than a decade ago for the defunct Bank of New England Corp.

The settlement in the long-forgotten case, one of the largest Ernst has made, is a reminder of the litigation pressures on the Big Four accounting firms as they seek to restore public trust in their audit work.

The accord, reached yesterday, came about two weeks after trial proceedings had begun in a federal district court in Boston, and a few days after Douglas Carmichael, chief auditor of the Public Company Accounting Oversight Board, testified in court as the plaintiff's lead expert witness. Mr. Carmichael had been retained as an expert in the suit before he was hired by the accounting board, and the board permitted him to conclude his work.

Ernst denied liability. In a statement, an Ernst spokesman said: "We are pleased to have resolved this issue in a reasonable manner. We believe that it was in the best interest of all parties to resolve this matter to avoid continued litigation and legal costs."

The suit, filed by the bank's bankruptcy trustee in 1993, accused Ernst of malpractice, among other things. Amid pressure from federal banking regulators, who began warning the bank about its deteriorating financial condition in early 1989, the bank in January 1990 announced it would report more than $1 billion in previously undisclosed losses on bad loans for its 1989 fourth quarter. Just four months earlier, the bank had raised $250 million through a public debt offering. The bank filed for Chapter 7 bankruptcy protection in January 1991.

Bob Jensen's threads on bad audits are at http://www.trinity.edu/rjensen/FraudConclusion.htm#IncompetentAudits 

"Ernst & Young Is Sued Over Advice On CA Purchase of Software Firm," by William M. Bulkeley, The Wall Street Journal, February 15, 2005; Page A14 --- http://online.wsj.com/article/0,,SB110843854004254956,00.html?mod=home_whats_news_us 

Texas software entrepreneur who headed Sterling Software Inc. when it was sold to Computer Associates International Inc. in March 2000 filed suit against Ernst & Young LLP, which had audit relationships with both companies in the $4 billion transaction.

In his suit, filed in Texas District Court in Dallas, Sam Wyly claims he relied on Ernst & Young's audit of Computer Associates' books for fiscal 1999, which ended March 31, in making his decision to sell the company for Computer Associates stock. Barely a month later, the shares fell 12% in one day when the company delayed reporting year-end earnings, and later that year the stock declined again when Computer Associates failed to make the earnings it had forecast.

Computer Associates, a maker of enterprise software systems based in Islandia, N.Y., is emerging from a $2.2 billion accounting scandal that led to the indictment of its former chief executive, Sanjay Kumar, in September and the resignations and indictments of several other top officials. Mr. Kumar has pleaded not guilty to charges related to the company's financial problems. Computer Associates has admitted to backdating contracts and keeping its books open days after they were supposed to be closed on the last day of a quarter, in order to book extra revenue.

Continued in the article

Ernst & Young LLP has agreed to pay $1.5 million to settle allegations that the firm's advice led nine hospitals to over bill the federal Medicare program. --- http://www.accountingweb.com/item/99508

"Report Finds TIAA-CREF Missteps in Auditor Controversy," by Doug Lederman, Inside Higher Ed, May 6, 2005 --- http://www.insidehighered.com/news/2005/05/06/tiaa

TIAA-CREF’s leaders made “substantial missteps” in managing conflict of interest charges involving the relationship between some of its trustees and its external auditor (Ernst & Young) last year, but the company showed no bad faith and ultimately handled the situation correctly, a high-profile investigator hired by the company concluded Thursday.

In a report published on the pension giant’s Web site, Nicholas deB. Katzenbach, former U.S. attorney general, also blamed the problems on the company’s governance structure, which places a board of overseers over separate boards of directors for TIAA and CREF. The arrangement creates the “constant risk of potential and actual conflict,” the report said.

The report also states clearly that the conflict controversy did not “touch on the quality of TIAA-CREF’s management of investor funds, or the integrity of the financial statements it prepared.”

Two trustees — Stephen A. Ross of CREF and William H. Waltrip of TIAA — resigned last November after revelations that they had had a joint venture with Ernst & Young, the company’s auditor, a situation that violated the Securities and Exchange Commission’s rules on independent auditors.

Katzenbach’s 53-page report notes that TIAA-CREF officials, upon learning informally of the trustees’ relationship with the auditor, underestimated the gravity of the problem and failed to investigate the matter sufficiently.

“In sum, TIAA-CREF did not appreciate the seriousness of the independence issue. While its personnel recognized that there was a theoretical possibility of drastic consequences, they saw it as a technical violation that would almost certainly be resolved promptly and without difficulty,” Katzenbach wrote.

Continued in article

To download the report, go to http://www.tiaa-cref.org/pdf/katzenbach_report_4_29_05.pdf

Two TIAA-CREF trustees quit amid SEC pressure over a business venture they formed with Ernst & Young, the firm's auditor  Note that one of them a the famous academic professor in mathematical economics and finance from MIT.  Steve Ross is probably best known for his writings on Arbitrage Pricing Theory (APT) --- http://www.trinity.edu/rjensen/149wp/149wp.htm 

Also note that, two the firm's credit, Ernst & Young reported this violation of auditor independence to TIAA-CREF.  My question would be why an auditing firm would engage in such a venture in the first place even if there was no conflict of interest with a client.  Ernst and Young was already in a deep hole with the SEC before this conflict of interest came to the attention of the SEC.

"Venture Snares TIAA-CREF, Ernst," by Jonathan Weil and JoAnn S. Lublin, The Wall Street Journal, December 3, 2004; Page A8 --- http://online.wsj.com/article/0,,SB110204504468490286,00.html?mod=home_whats_news_us

Two TIAA-CREF trustees have resigned amid pressure by the Securities and Exchange Commission over a business venture they formed last year with Ernst & Young LLP, the investing titan's independent auditor, in violation of SEC auditor-independence rules.

The nation's largest institutional investor, which manages $325 billion in assets, plans to disclose the resignations of William H. Waltrip and Stephen A. Ross in an SEC filing today, people familiar with the matter said.

The episode is likely to be a major embarrassment to TIAA-CREF, among the world's leading corporate-governance activists, and Ernst. This year the audit firm was suspended by the SEC from accepting new publicly held audit clients for six months over a business partnership it entered during the 1990s with PeopleSoft Inc., a former audit client.

According to federal auditor-independence rules, outside auditors are prohibited from forming business ventures with audit clients, including their executives, board members or trustees. According to people familiar with the matter, the SEC has agreed to allow Ernst to conclude its audit for this year, but TIAA-CREF will put its audit out for bidding by other firms next year and likely will hire a different accounting firm. Ernst has been TIAA-CREF's auditor for about seven years.

A board of overseers presides over TIAA-CREF's structure, which includes two other boards of trustees, one for the Teachers Insurance & Annuity Association of America and one for the College Retirement Equities Fund. Mr. Waltrip was a TIAA trustee, and Mr. Ross was a CREF trustee.

On Aug. 1, 2003, Ernst entered into an agreement with a company owned by Messrs. Waltrip and Ross, called Compensation Valuation Inc. Mr. Ross was CVI's chief executive and majority owner. Ernst formed the venture with the two trustees' company to sell services that help businesses determine the value of corporate stock options. Ernst paid the company $1.33 million, according to people familiar with the matter.

Ernst notified certain TIAA-CREF officials and the SEC about the independence violation Aug. 9, these people said. Aug. 20, the trustees' company ceased operations. However, the trustees' company wasn't actually dissolved until Nov. 17, and members of the TIAA-CREF board of overseers weren't told about the auditor-independence problem until this week, angering some of them, people familiar with the matter said.

Mr. Ross is a finance professor at Massachusetts Institute of Technology and a director at Freddie Mac. Mr. Waltrip is the former chairman of Technology Solutions Co. Neither man returned phone calls yesterday. Their resignations took effect Nov. 30. A TIAA-CREF spokeswoman, Stephanie Cohen-Glass, declined to comment yesterday. In a statement, Ernst said the firm had identified the matter itself and confirmed that it notified TIAA-CREF and the SEC. The Big Four accounting firm said it is "in the midst of implementing new independence procedures and identifying any client issues," but declined to discuss specifics.

Messrs. Waltrip and Ross were powerful trustees who played important roles in the recruitment of Herbert M. Allison Jr., the former Merrill Lynch & Co. president who became the huge fund's chairman, president and CEO in November 2002. Mr. Waltrip was chairman of the search committee, of which Mr. Ross was a member.

Continued in the article

TIAA-CREF Brass Failed to Inform Key Panel About Improper Deal With Ernst, Its Outside Auditor

The SEC's chief accountant, Donald Nicolaisen, last week told TIAA-CREF that Ernst could complete its 2004 audit, but that he would be very upset if it rehires Ernst for its 2005 audit, people close to TIAA-CREF said.  The saga marks yet another embarrassment for Ernst and its chairman and CEO, James Turley. In April, the SEC suspended the Big Four accounting firm from accepting new audit clients for six months because of a 1990s business venture with audit client PeopleSoft Inc. Under the SEC's auditor-independence rules, accounting firms aren't permitted to form business ventures with audit clients, including their officers, directors or trustees.
"TIAA-CREF Faces Question On Governance," by Jonathan Weil and Joann S, Lublin, The Wall Street Journal, December 6, 2004, Page C1 --- http://online.wsj.com/article/0,,SB110229989626191715,00.html?mod=home_whats_news_us 

 

TIAA-CREF, a longtime standard bearer for the corporate-governance movement, now has a governance mess of its own, sparked by two trustees' improper business deal with outside auditor Ernst & Young LLP and a decision by the investing titan's top brass not to promptly inform the fund's powerful board of overseers about the problem.

The conflict centers on a contract that the two TIAA-CREF trustees entered into with Ernst in August 2003 to jointly sell valuation services for corporate stock options, in violation of federal auditor-independence rules. Last week, the two trustees resigned, amid pressure from the Securities and Exchange Commission's office of chief accountant. Separately, the SEC's enforcement division has opened an inquiry into the events surrounding the violation, people familiar with it say.

TIAA-CREF Chairman and Chief Executive Officer Herbert M. Allison Jr. knew about the independence violation as of Aug. 9, when Ernst first notified the company and the SEC. However, before late last week, he had informed only one of his six fellow members on TIAA-CREF's star-studded board of overseers about the matter. The panel is one of three boards at TIAA-CREF that share control of the nation's largest pension system, which manages $326 billion of assets for 3.2 million people.

TIAA-CREF's general counsel, George Madison, on Friday said the other two boards' trustees were told in August and that, under TIAA-CREF's unique corporate structure, Mr. Allison wasn't obligated until last week to notify the full board of overseers. Messrs. Allison and Madison did tell Stanley O. Ikenberry, the president of the board of overseers, in September. But Mr. Ikenberry didn't tell the other overseers either, among them, former SEC Chairman Arthur Levitt.

Instead, Mr. Ikenberry's colleagues were left in the dark until Thursday, one day before TIAA-CREF disclosed the violation in SEC filings. Corporate-governance activists long have pushed for companies to disclose any significant bad news as early and widely as possible.

Through a TIAA-CREF spokesman, Mr. Allison said: "I, along with my management team, continue to work for the best interests of the participants and our institutions to strengthen TIAA-CREF for the competitive challenges we are facing." He declined to comment further.

The saga marks yet another embarrassment for Ernst and its chairman and CEO, James Turley. In April, the SEC suspended the Big Four accounting firm from accepting new audit clients for six months because of a 1990s business venture with audit client PeopleSoft Inc. Under the SEC's auditor-independence rules, accounting firms aren't permitted to form business ventures with audit clients, including their officers, directors or trustees.

The SEC's chief accountant, Donald Nicolaisen, last week told TIAA-CREF that Ernst could complete its 2004 audit, but that he would be very upset if it rehires Ernst for its 2005 audit, people close to TIAA-CREF said.

Continued in Article

Another Audit Client Dumps Ernst & Young

"Best Buy to Dismiss Auditor Ernst, Citing Conflict of Interest," by Jonathan Weil, The Wall Street Journal, December 31, 2004, Page C1 --- http://online.wsj.com/article/0,,SB110441683676412888,00.html?mod=todays_us_money_and_investing

Best Buy Co. said it is dropping Ernst & Young LLP as its outside auditor next year, citing a conflict of interest stemming from a business relationship between the Big Four accounting firm and a former Best Buy director.

The nation's largest electronics retailer said its dismissal of Ernst will take effect upon the completion of its audit for the fiscal year ending Feb. 26, 2005. The Richfield, Minn., company said it will put work on its fiscal 2006 audit out for bids sometime next year.

The move by Best Buy is the latest in a series of recent auditor-independence controversies for Ernst. In April, the Securities and Exchange Commission imposed a six-month suspension on the firm, during which Ernst was barred from accepting new publicly held audit clients. The SEC case centered on an improper joint venture with former audit client PeopleSoft Inc. In her decision imposing the suspension, the SEC's chief administrative-law judge, Brenda P. Murray, wrote that Ernst "had no procedures in place that could reasonably be expected to deter violations and assure compliance with the rules on auditor independence with respect to business dealings with audit clients."

Since that decision, under an SEC-mandated independent review of its dealings with audit clients, Ernst has notified dozens of clients of auditor-independence violations, though few have been deemed serious enough to warrant Ernst's dismissal. The violations have included improperly taking custody of clients' cash when performing tax work overseas and engaging in direct business relationships with audit clients, among other things.

Generally, SEC rules prohibit direct business relationships between accounting firms and their audit clients, including officers, directors and trustees. The one exception is where a firm is acting as a consumer in the ordinary course of business.

This month, officials at TIAA-CREF, a large institutional investor that also is a prominent corporate-governance activist, said the fund probably would drop Ernst next year, once its 2004 audit is because of a business relationship that the accounting firm entered into last year with two of the fund's trustees. Both the TIAA-CREF and Best Buy matters remain the subjects of SEC inquiries.

In an SEC filing yesterday, Best Buy said its dismissal of Ernst was directly related to the May 4 resignation of Mark C. Thompson from the company's board. Mr. Thompson, a "leadership development" consultant and former Charles Schwab Corp. executive, was a member of Best Buy's audit committee from 2000 through 2003.

In a May 14 SEC filing disclosing Mr. Thompson's resignation, Best Buy said neither Ernst nor Mr. Thompson had disclosed their business relationship to the company until May 4. Ernst paid Mr. Thompson $377,500 plus expense reimbursements from December 2002 to April 2004, according to Best Buy filings. Ernst's payments to Mr. Thompson stem from audio interviews he conducted with leading corporate executives, industry executives and Ernst's own executives for the accounting firm's marketing materials. In regulatory disclosures, Best Buy has said Mr. Thompson had a "personal service agreement" with Ernst.

More Bad News for Ernst &Young

"Former E&Y Audit Partner Faces Five Years on Obstruction Charges," AccountingWeb, November 4, 2004 --- http://www.accountingweb.com/cgi-bin/item.cgi?id=100035 

AccountingWEB.com - Nov-4-2004 - Former Ernst & Young audit partner Thomas Trauger went to great lengths to keep from being “second-guessed” and last week pleaded guilty to charges he obstructed a federal investigation. The subject of the government's probe was NextCard Inc., a San Francisco company that distributed credit cards via the Internet. The company's troubles began when it handed out too many cards to unqualified holders, the Associated Press reported. Federal regulators shut down the company's banking unit in early 2002.

Trauger admitted to knowingly altering, destroying and falsifying records with the intent to impede and obstruct an investigation by the U.S. Attorney's Office, CFO.com reported, but at heart, his goal was seemingly to avoid being "second-guessed" for failing to recognize red flags at a company that he had audited.

SEC official Robert Mitchell was interviewed at 

the time of Trauger's September 2003 arrest and said the audit partner was trying to "downplay or eliminate evidence of problems" that would have been red flags, according to USA Today, adding that he had previously given the company a clean bill of health.

An FBI affidavit showed that Trauger wanted to give the appearance that E&Y's audit of NextCard had been "right on the mark" so that "some smart-ass lawyer" wouldn't be able to second-guess him, the San Francisco Recorder, a legal newspaper, reported.

Trauger admitted last week that when testifying before the SEC he had failed to disclose that NextCard documents and quarterly working papers had been tampered with.

Continued in the article

Another Earnings Smoothing Fraud

"SEC CHARGES FORMER CEO AND TWO FORMER EXECUTIVES AFFILIATED WITH RENAISSANCERE HOLDINGS LTD. WITH SECURITIES FRAUD," AccountingEducation.com, October 26, 2006 --- http://accountingeducation.com/index.cfm?page=newsdetails&id=143780

The Securities and Exchange Commission on September 27, 2006 announced securities fraud charges against James N. Stanard and Martin J. Merritt, the former CEO and former controller, respectively, of RenaissanceRe Holdings Ltd. (RenRe) and also against Michael W. Cash, a former senior executive of RenRe's wholly-owned subsidiary, Renaissance Reinsurance Ltd. The complaint, filed in the federal court in Manhattan, alleges that Stanard, Merritt, and Cash structured and executed a sham transaction that had no economic substance and no purpose other than to smooth and defer over $26 million of RenRe's earnings from 2001 to 2002 and 2003. The Commission also announced a partial settlement of its charges against Merritt, who has consented to the entry of an antifraud injunction and other relief.

Mark K. Schonfeld, Director of the Commission's Northeast Regional Office, said, "This is another case arising from our ongoing investigation of the misuse of finite reinsurance to commit securities fraud. The defendants enabled RenRe to take excess revenue from one good year and, in effect, 'park' it with a counterparty so it would be available to bring back in a future year when the company's financial picture was not as bright."

Andrew M. Calamari, Associate Director of the Commission's Northeast Regional Office, said, "The investing public relies upon senior executives of public companies not to engage in transactions that are designed to misstate their companies' financial statements. Today's enforcement action underscores that the Commission will pursue culpable senior officials who are instrumental in constructing fraudulent transactions."

The Defendants

• Stanard, age 57 and a resident of Maryland and Bermuda, was Ren Re's chairman and chief executive officer from 1993 until he resigned in November 2005.
   
• Merritt, age 43 and a Bermuda resident, held various positions, including that of controller, at both the holding company and the subsidiary.
   
• Cash, age 38 and a Bermuda resident, was a senior vice president of the subsidiary until he resigned in July 2005.

RenRe's Fraud

The Commission alleges that Stanard, Merritt and Cash committed fraud in connection with a sham transaction that they concocted to smooth RenRe's earnings. The complaint concerns two seemingly separate, unrelated contracts that were, in fact, intertwined. Together, the contracts created a round trip of cash. In the first contract, RenRe purported to assign at a discount $50 million of recoverables due to RenRe under certain industry loss warranty contracts to Inter-Ocean Reinsurance Company, Ltd. in exchange for $30 million in cash, for a net transfer to Inter-Ocean of $20 million. RenRe recorded income of $30 million upon executing the assignment agreement. The remaining $20 million of its $50 million assignment became part of a "bank" or "cookie jar" that RenRe used in later periods to bolster income.

The second contract was a purported reinsurance agreement with Inter-Ocean that was, in fact, a vehicle to refund to RenRe the $20 million transferred under the assignment agreement plus the purported insurance premium paid under the reinsurance agreement. This reinsurance agreement was a complete sham. Not only was RenRe certain to meet the conditions for coverage; it also would receive back all of the money paid to Inter-Ocean under the agreements plus investment income earned on the money in the interim, less transactional fees and costs.

RenRe accounted for the sham transaction as if it involved a real reinsurance contract that transferred risk from RenRe to Inter-Ocean when in fact, the complaint alleges, each of these individuals knew that this was not true. Merritt and Stanard also misrepresented or omitted certain key facts about the transaction to RenRe's auditors. As a result of RenRe's accounting treatment for this transaction, RenRe materially understated income in 2001 and materially overstated income in 2002, at which time it made a "claim" under the "reinsurance" agreement. It then received as apparent reinsurance proceeds the funds it had paid to Inter-Ocean and that Inter-Ocean held in a trust for RenRe's benefit.

On Feb. 22, 2005, RenRe issued a press release announcing that it would restate its financial statements for the years ended Dec. 31, 2001, 2002 and 2003. On March 31, 2005, RenRe filed its Form 10-K for the year ended Dec. 31, 2004, which contained restated financial statements for those years. Stanard signed and certified the 2004 Form 10-K. Both the press release and the Form 10-K attributed the restatement of the Inter-Ocean transaction to accounting "errors" due to "the timing of the recognition of Inter-Ocean reinsurance recoverables." These statements were misleading. In fact, the transaction contained no real reinsurance and the company's restated financial statements accounted for the transaction as if it had never occurred. In short, the entire transaction was a sham, and the company failed to disclose that fact and misrepresented the reasons for the restatement.

The Commission's Charges

The Commission's complaint charges Stanard, Merritt and Cash with securities fraud in violation of Section 17(a) of the Securities Act and Section 10(b) and Rule 10b-5(a), (b) and (c) of the Exchange Act; with violating the reporting, books-and-records and internal control provisions of Exchange Act Section 13(b)(5) and Rule 13b2-1; and with aiding and abetting RenRe's violations of Exchange Act Sections 10(b), 13(a) and 13(b)(2) and Exchange Act Rules 10b-5(a), (b) and (c), 12b-20, 13a-1 and 13a-13. In addition, the complaint charges Stanard and Merritt with violating Exchange Act Rule 13b2-2 for making materially false statements to RenRe's auditors and charges Stanard with violating Exchange Act Rule 13a-14 for certifying financial statements filed with the Commission that he knew contained materially false and misleading information. The complaint seeks permanent injunctive relief, disgorgement of ill-gotten gains, if any, plus prejudgment interest, civil money penalties, and orders barring each defendant from acting as an officer or director of any public company.

Partial Resolution

Merritt agreed to partially settle the Commission's claims against him. In addition to undertaking to cooperate fully with the Commission, and without admitting or denying the allegations in the complaint, Merritt consented to a partial final judgment that, upon entry by the court, will permanently enjoin him from violating or aiding or abetting future violations of the securities laws, bar him from serving as an officer or director of a public company, and defer the determination of civil penalties and disgorgement to a later date. Merritt also agreed to a Commission administrative order, based on the injunction, barring him from appearing or practicing before the Commission as an accountant, under Rule 102(e) of the Commission's Rules of Practice. Merritt was a certified public accountant licensed to practice in Massachusetts.

The independent auditor caught up in this fraud is Ernst & Young. You can read more about Ernst & Young's troubles at
http://www.trinity.edu/rjensen/Fraud001.htm#Ernst

"Ernst & Young's Survival Threatened by Equitable Life Case," AccountngWeb, August 16, 2004 --- http://www.accountingweb.com/cgi-bin/item.cgi?id=99625 

Back in the heady days of the 1990s, it was unimaginable that the existence of even one of the Big Five accounting firms could ever be threatened. The collapse of Arthur Andersen left a Big Four and one more faces the possibility of collapse if a negligence claim against the firm is successful. Ernst & Young's battle with Equitable Life took on epic proportions in the United Kingdom this week, with Ernst & Young's chairman Nick Land writing to the Office of Fair Trading to put the office on notice that the firm's potential liability exceeds its insurance coverage.

In Land's letter to Office of Fair Trading Chairman John Vickers, Land signaled the company could collapse if Equitable Life succeeds in its £2.6bn negligence claim with Ernst & Young. Land wrote, 'our cover is not adequate to meet claims at the level we are currently facing.' The case is due to be heard at the High Court in April, the UK's Financial Director magazine reported.

A spokesman for Equitable Life said that 'the board's advice is that it has a strong claim against E&Y,' although he would not comment on whether it would seek a settlement or take the case to trial.

Meanwhile, E&Y was due to submit its response to complaints made by the Joint Disciplinary Scheme by Friday last week. Roland Foord, a partner at City law firm Stephenson Harwood, said that while the JDS findings would not influence the civil judge should a trial go ahead, it 'could have some effect in terms of settlement' decisions, Financial Director reported.

Washington's insurance commissioner is seeking millions of dollars from accounting firm Ernst & Young for its alleged neglect in overseeing finances at Metropolitan Mortgage & Securities.  
Washington State Sues E&Y Over Met Mortgage Woes," AccounitngWeb, October 19m 2004 --- http://www.accountingweb.com/cgi-bin/item.cgi?id=99940 

Ernst & Young already has put into effect changes to the way it audits savings-and-loan associations that comply with the OTS consent order, the firm said. "And we are voluntarily taking the extra step of implementing these changes throughout our bank audit practice," said Charles Perkins, a spokesman in New York.

"Ernst & Young Settles Charges For $125 Million," The Wall Street Journal, December 27, 2004, Page B3 --- http://online.wsj.com/article/0,,SB110411348322509799,00.html?mod=todays_us_marketplace 

Ernst & Young LLP, one of the four largest U.S. accounting firms, agreed to pay a total of $125 million to settle U.S. claims arising from its audits of a failed Illinois savings bank.

Under a consent order agreed to with the Office of Thrift Supervision, the New York-based partnership will pay the Federal Deposit Insurance Corp. $85 million as receiver for the failed Superior Bank FSB. In addition, Ernst & Young will pay $40 million in restitution to the FDIC, which insures deposits at the 9,025 U.S. banks and savings-and-loan associations, said an FDIC spokesman.

Superior was declared insolvent in July 2001 after running into trouble over its loans to borrowers with spotty credit records. At the time of its failure, Superior had assets of about $2 billion. The FDIC sued Ernst & Young in 2002, contending that it delayed alerting regulators to improper accounting practices at the thrift out of concern that negative publicity could disrupt the sale of its consulting unit.

In April 2003, a federal judge dismissed the suit, saying the FDIC wasn't able to sue in its capacity as administrator for the government's Bank Insurance Fund and Savings Association Fund. The FDIC appealed the decision.

Ernst has disputed allegations that it was to blame for the bank's failure, citing testimony in 2002 before the Senate by the FDIC's inspector general that Superior Bank's failure was "directly attributable" to "the bank's board of directors and executives ignoring sound risk-management principles."

In settling, Ernst & Young didn't admit or deny that its audits failed to comply with any professional accounting standards. It said the decision to settle underscored a commitment to work cooperatively with regulators and to make sure the firm had "the strongest policies and procedures to serve our clients and the public interest."

Ernst & Young already has put into effect changes to the way it audits savings-and-loan associations that comply with the OTS consent order, the firm said. "And we are voluntarily taking the extra step of implementing these changes throughout our bank audit practice," said Charles Perkins, a spokesman in New York.

"Ernst & Young Gets SEC Penalty For Ties to Client," by Jonathan Weil, The Wall Street Journal, April 19, 2004 --- http://online.wsj.com/article/0,,SB108214408244385161,00.html?mod=home_whats_news_us 

In one of the longest suspensions ever of a major accounting firm, Ernst & Young LLP was barred for six months from accepting any new audit clients among publicly traded companies as punishment for participating in a lucrative business venture with a company whose books it audited.

The ruling Friday by the Securities and Exchange Commission's chief administrative-law judge marks the latest sanction of an accounting firm for violating the agency's auditor-independence rules, which are intended to ensure that accounting firms remain impartial in their evaluations of corporate clients' financial statements. The suspension applies to American or foreign companies whose stock or debt trades on U.S. markets.

Ernst had fiercely contested the SEC enforcement division's allegations that it compromised its independence by engaging in a joint venture with PeopleSoft Inc. at the same time that it was the software maker's outside auditor, at one point calling the allegations "outrageous." On Friday, Ernst, the nation's third-largest accounting firm, said it wouldn't appeal the decision.

The conduct occurred in the 1990s, at a time when accounting firms' fees weren't disclosed and the prevailing culture within the major firms was to use audits as a loss leader to generate other, more-lucrative business with clients.

Three of the four major accounting firms, including Ernst, since have sold their consulting practices in response to pressure from regulators. Only Deloitte & Touche LLP continues to maintain a sizable consulting practice, though it too has come under pressure to part ways with its consulting business. Nowadays, companies with publicly traded securities must disclose how much they pay their independent accounting firms for audit and nonaudit work.

Continued in the article

"Big Auditing Firm Gets 6-Month Ban on New Business," by Floyd Morris, The New York Times, April 17, 2004 ---  http://www.nytimes.com/2004/04/17/business/17ERNS.html 

Ernst & Young, the big accounting firm, was barred yesterday from accepting any new audit clients in the United States for six months after a judge found that the firm acted improperly by auditing a company with which it had a highly profitable business relationship.

The unusual order, which included a $1.7 million fine, brought to an end a bitter fight in which the Securities and Exchange Commission had contended that Ernst violated rules on auditor independence by jointly marketing consulting and tax services with an audit client, PeopleSoft Inc.

The overwhelming evidence," wrote Brenda P. Murray, the chief administrative law judge at the S.E.C., is that Ernst's "day-to-day operations were profit-driven and ignored considerations of auditor independence." She said the firm "committed repeated violations of the auditor independence standards by conduct that was reckless, highly unreasonable and negligent."

The rebuke to Ernst, which said it would not appeal the decision, is the latest embarrassment for one of the Big Four accounting firms, which have come under heavy criticism and increased regulation as a result of accounting scandals in recent years. Those scandals led to the demise of Arthur Andersen, which had formerly been among the Big Five.

The judge was harshly critical of the Ernst partner who was in charge of independence issues, saying he kept no written records and had failed to learn enough facts before saying the relationships between Ernst and PeopleSoft were proper. That partner, Edmund Coulson, was chief accountant of the S.E.C. before he joined Ernst in 1991.

Ernst's consulting and tax practices used PeopleSoft software in their business, and the two companies participated in some joint promotion activities. Ernst contended that it should be viewed as a customer of PeopleSoft in the relationship, but the judge said it went far beyond that.

She noted that Ernst had billed itself in marketing materials as an "implementation partner" of PeopleSoft and had earned $500 million over five years from installing PeopleSoft programs at other companies, which use the software to manage payroll, human resources and accounting operations.

She issued a cease-and-desist order against the firm, saying it had refused to admit it had done anything wrong and that there was no reason to believe it would not violate the rules again. She also fined it $1,686,500, the total amount of audit fees the company received from PeopleSoft in the years that were involved, plus interest of $729,302, and ordered that an outside monitor be brought in to assure the firm complied with the rules in the future.

S.E.C. officials said the decision would send a message to other firms. "Auditor independence is one of the centerpieces of ensuring the integrity of the audit process," said Paul Berger, an associate director of the commission's enforcement division, adding that the judge's decision "vindicates our view that Ernst & Young engaged in a business relationship that clearly violated" the rules.

Ernst, based in New York, had previously denounced the commission for seeking a ban on new business, saying any such punishment was completely unwarranted. But last night the firm said it would accept the ruling and would not appeal. It had the right to appeal to the full S.E.C. and then to federal courts if the commission ruled against it.

"Independence is the cornerstone of our practice and our obligation to the public," said Charlie Perkins, a spokesman for Ernst & Young. "We are fully committed to working closely with an outside consultant in the review of our independence policies and procedures."

Mr. Perkins said the firm had decided not to appeal because it wanted to put the matter behind it, and emphasized that it would be able to continue serving its existing clients.

The six-month suspension appears to match the longest suspension on signing new business ever imposed on a leading accounting firm.

In 1975, Peat Marwick, a predecessor of KPMG, agreed to accept a similar six-month suspension as part of a settlement of charges it had failed to properly audit five companies, including Penn Central, the railroad that went bankrupt.

Federal investigators have launched a criminal investigation into Ernst & Young's tax shelter practices, despite the $15 million settlement the firm reached on the matter last year with the IRS. http://www.accountingweb.com/item/99225
Related News: http://www.accountingweb.com/firm.html

Reports coming out of the US tell us that Ernst & Young has been selling wealthy US citizens four legal techniques for reducing their income tax bill, one of which experts claim could be illegal.
Accountancy Age, June 21, 2002 --- http://www.financialdirector.co.uk/News/1129611 

"SEC Begins Probe Into Ernst's Pacts: Regulator to Weigh If Ties To AMR, Others Met Rules For Auditor-Independence," by Jonathan Weil, The Wall Street Journal, December 8, 2003 --- http://online.wsj.com/article/0,,SB107084523554066200,00.html?mod=mkts_main_news_hs_h

The Securities and Exchange Commission's enforcement division has begun an inquiry into Ernst & Young LLP's business relationships with three major audit clients, including American Express Co., and whether the dealings were appropriate under federal auditor-independence rules.

Ernst's contracts with American Express, AMR Corp.'s American Airlines, and Continental Airlines for travel services came to light this autumn in connection with a lawsuit in an Arkansas state circuit court where Ernst and other accounting firms are contesting allegations that they overbilled clients for travel expenses. In a court filing last week, attorneys for the plaintiff said they received a request from a federal agency for documents relating to Ernst's relationships with the three companies, which were the subject of Wall Street Journal articles on Nov. 20.

"We will fully cooperate with the SEC in its review of this matter," Ernst said in a statement, confirming the agency's identity. An SEC spokesman declined to comment.

One October 1996 contract called for American Express, as Ernst's exclusive travel agent, to receive commissions on all Ernst airfare, hotel rooms and car rentals and return a portion to Ernst. A section called "profit sharing" said Ernst would receive 53% and American Express 47% "of the net profit of Total Commission Revenue and pooled expenses." Ernst also received portions of commissions paid to American Express on leisure travel booked by Ernst employees.

Continued in article

Guess who ultimately ends up paying the $510 million for accounting fraud?

"Time Warner to pay 510-million-dollar fraud settlement," TurkishPress.com, December 15, 2004 --- http://www.turkishpress.com/news.asp?ID=34926 

Time Warner, the world's largest media-entertainment company, said Wednesday it had agreed to pay a total of 510 million dollars to resolve federal probes into accounting irregularities at its America Online (AOL) units.

The company said 210 million dollars would be paid in agreement with the Department of Justice (DoJ), while a further 300-million-dollar penalty would be levied under a proposed settlement with the Securities and Exchange Commission (SEC).

Deputy US Attorney General James Comey said the Justice Department would file a criminal complaint against AOL that charges several employees with securities fraud.

However, the prosecution will be deferred for two years and then dismissed, so long as the company adheres to all stipulations of its deal with the government.

"If AOL fails to comply with the agreement, the deal is off. And they are in a world of trouble," Comey said.

As well as the 210-million-dollar payout, the agreement requires AOL to undertake a wide range of corporate reforms.

The charges levelled against AOL arose out of a scheme to falsify the financial results of a company called Purchase Pro -- a dot-come startup which is now bankrupt.

"As so often happens, during the dot-com bubble days, the revenues that AOL and Purchase Pro were counting on did not materialize, Comey said.

"And instead of confronting that harsh reality, AOL and Purchase Pro cooked up a scheme to inflate Purchase Pro's revenues," he added.

Four former Purchase Pro executives have agreed to plead guilty to felony charges based on their roles in the scheme.

The multi-million dollar settlement incorporates a 60-million-dollar fine and the establishment of a 150-million-dollar fund to settle any related shareholder or securities legislation.

The proposed 300-million-dollar settlement with the SEC would resolve an investigation by the securities watchdog into whether AOL improperly accounted for a 400-million-dollar payment made by German media company Bertelsmann, which used to own 50 percent of AOL Europe.

Question
How can you "PUT" away your cares about clear-cut rules of accounting?

Answer
See how AOL did it in conspiracy with Goldman Sachs

With the AOL-Time Warner deal due to close in just three months, Bertelsmann needed to reduce its AOL Europe holding -- pronto. But the obvious buyer, AOL, didn't want to own more than 50% or more of the venture, either. Going above half might trigger a U.S. accounting rule that would force AOL to consolidate all the struggling unit's losses on its books when AOL was already grappling with deteriorating ad revenues and a declining stock price. Enter Goldman Sachs Group Inc. (GS ) Business Week has learned that the premier Wall Street bank agreed to buy 1% of AOL Europe -- half a percent from each parent -- for $215 million. AOL Europe, in return, agreed to a "put" contract promising Goldman that it could sell back the 1% by a specific date and at a set price. That simple transaction solved Bertelsmann's EU problem without trapping AOL in an accounting conundrum -- a perfect solution.

"Goldman's 1% Solution," by Paula Dwyer, Business Week, June 28, 2004 --- http://www.businessweek.com/@@ajkOUmUQQWvg7RMA/premium/content/04_26/b3889045_mz011.htm?se=1 

Goldman's 1% Solution
In 2000, it cut a questionable deal that smoothed the AOL-Time Warner merger. Will the SEC take action?

In more ways than one, the news from the European Union was bad. It was October, 2000, and the EU's executive arm, the European Commission, had just jolted America Online Inc. with a ruling that its pending acquisition of Time Warner Inc. (TWX ) could harm competition in Europe's media markets, especially the emerging online music business. The EC was concerned that AOL was a 50-50 partner with German media giant Bertelsmann in one of Europe's biggest Internet service providers, AOL Europe. Now the EC was ordering Bertelsmann to give up control over AOL Europe.

With the AOL-Time Warner deal due to close in just three months, Bertelsmann needed to reduce its AOL Europe holding -- pronto. But the obvious buyer, AOL, didn't want to own more than 50% or more of the venture, either. Going above half might trigger a U.S. accounting rule that would force AOL to consolidate all the struggling unit's losses on its books when AOL was already grappling with deteriorating ad revenues and a declining stock price.

Enter Goldman Sachs Group Inc. (GS ) Business Week has learned that the premier Wall Street bank agreed to buy 1% of AOL Europe -- half a percent from each parent -- for $215 million. AOL Europe, in return, agreed to a "put" contract promising Goldman that it could sell back the 1% by a specific date and at a set price. That simple transaction solved Bertelsmann's EU problem without trapping AOL in an accounting conundrum -- a perfect solution.

LEGAL HEADACHES 

Or so it seemed at the time. But the deal also may have violated U.S. securities laws. The Securities A: Exchange Commission and the Justice Dept. have construed some deals involving promises to buy back assets at a specific time and price as share-parking arrangements designed to mislead investors. The former chief executive of AOL Europe says the Goldman deal may have kept up to $200 million in 2000 losses off of the combined AOL-Time Warner financials -- enough, he says, that Time Warner might have tried to change the terms of the $120 billion merger, since AOL wouldn't have looked as healthy. But as the deal moved toward consummation, the Goldman arrangement was never disclosed in public documents to AOL or Time Warner shareholders.

The AOL Europe transaction threatens to create problems for Goldman Sachs. But it could also prolong the legal headaches of Time Warner Inc., as the AOL-Time Warner combine is now called. For the past two years, Time Warner has been in heated negotiations with the SEC over AOL's accounting for advertising revenues (BW -- June 7). Just as the SEC is wrapping up that case -- it could warn Time Warner as early as this summer that it intends to bring civil fraud charges -- the Goldman transaction raises troubling new questions about AOL's financial dealings prior to the merger.

The SEC has not brought charges over the 1% solution, and an SEC spokesman would not comment on whether the agency is probing the deal. Time Warner spokeswoman Tricia Primrose Wallace says the company will not comment on any part of the Goldman arrangement. A lawyer for Stephen M. Case, AOL's chairman and CEO at the time of the deal, referred questions to Time Warner. Thomas Middelhoff, who was Bertelsmann's chairman at the time of the deal and negotiated the AOL Europe joint venture with Case in 1995, says through a spokesman that the sale of a 0.5% stake was "purely a financial technique" handled by others. And Lucas van Praag, a Goldman Sachs spokesman, says: "We handled this entirely appropriately. We don't believe there is anything untoward here."

Continued in the article

 

"University of California, Bank Sue AOL:  Lawsuit claims firm lied about finances, cost them," by Pamela Tate, The Wall Street Journal, April 15, 2003 --- http://www.yourlawyer.com/practice/printnews.htm?story_id=5448 

The University of California has joined with Amalgamated Bank to file a lawsuit against AOL Time Warner Inc., claiming their stakes have lost more than $500 million in value because the media company allegedly lied about its financial condition.

The University of California, which dropped out of a federal class-action suit against AOL earlier this month, filed the complaint Monday in the Superior Court of California in Los Angeles. The university and co-plaintiff Amalgamated Bank, a New York institution that manages funds for several dozen union pension funds, are being represented by Milberg Weiss Bershad Hynes & Lerach.

The plaintiffs allege that AOL Time Warner materially misrepresented its revenue and subscriber growth after the merger of AOL and Time Warner in January 2001. In two separate restatements in October and March, AOL slashed nearly $600 million from previously reported revenue over the past two years.

The University of California and Amalgamated allege that AOL's admissions so far have been "too conservative," and that the company may have overstated results by almost $1 billion.

In a March 28 filing with the Securities and Exchange Commission, AOL Time Warner said it faces 30 shareholder lawsuits that have been centralized in the U.S. District Court for the Southern District of New York. The company said in the filing it intends to defend itself "vigorously." The lawsuit filed by the University of California and Amalgamated names several current and former AOL Time Warner executives, as well as financial-services giants Citigroup and Morgan Stanley.

Citigroup is the parent of Salomon Smith Barney, now called Smith Barney, which with Morgan Stanley allegedly reaped $135 million in advisory fees from the AOL and Time Warner merger.

Defendants include Stephen Case, who resigned as chairman in January; former Chief Executive Gerald Levin, who left the company in May; current Chairman and Chief Executive Richard Parsons; and Ted Turner, who recently stepped down as vice chairman.

The lawsuit claims they and more than two dozen other insiders sold off $779 million in stock just after the merger closed but before the accounting revelations that would cause the stock price to plummet. The suit also names AOL's auditor, Ernst & Young.

The University of California claims it lost $450 million in the value of its AOL Time Warner shares, which were converted from more than 11.3 million Time Warner shares in the merger. At the end of 2002, the value of the university's portfolio was at $49.9 billion.

Continued in the article

Cendant CEO Guilty at Cendant in 3rd Trial
It took eight years and three trials, but federal prosecutors finally won their case on Tuesday against Walter A. Forbes, the former chairman of the Cendant Corporation. Mr. Forbes was convicted here on charges that he masterminded an accounting fraud that was considered at the time it was discovered — 1998 — to be the largest on record. Investors lost $19 billion when Cendant’s stock fell after the disclosure. The Cendant fraud was later eclipsed by the scandals at Enron and WorldCom. A jury of eight men and four women in Federal District Court deliberated for two and a half days before finding Mr. Forbes, 63, of New Canaan, Conn., guilty of conspiracy and of two counts of submitting false reports to the Securities and Exchange Commission in overstating his company’s earnings by more than $250 million. He was acquitted on a fourth count, securities fraud.
Stacey Stowe, "Chief Guilty at Cendant in 3rd Trial," The New York Times, November 1, 2006 ---
http://www.nytimes.com/2006/11/01/business/01cendant.html?ref=business

The company's auditor, Ernst & Young, paid $335 million to settle.

"Before Enron, There Was Cendant," by Gretchen Morgenson, The New York Times, May 9, 2004 --- http://www.nytimes.com/2004/05/09/business/yourmoney/09watch.html 

The fraud that time forgot is finally going to trial.

Tomorrow in Federal District Court in Hartford, opening arguments are scheduled to begin in the case against Walter A. Forbes, former chairman of the Cendant Corporation, and E. Kirk Shelton, former vice chairman. The government has accused the two men of orchestrating a titanic accounting and securities fraud that misled investors over a decade beginning in the late 1980's. The trial will open more than six years after the problems at Cendant came to light.

Cendant was formed in late 1997 when CUC International, a seller of shopping-club memberships that was run by Mr. Forbes, merged with HFS Inc., a hotel, car-rental and real estate company overseen by Henry R. Silverman.

Three months after the merger, Cendant disclosed evidence of accounting irregularities; the stock lost almost half its value in one day. Later, Cendant told investors that operating profits for the three years beginning in 1995 would be reduced by $640 million.

Mr. Forbes and Mr. Shelton have been accused of securities fraud, conspiracy and lying to the Securities and Exchange Commission. The charges of fraud and making false statements to regulators each carry a maximum penalty of 10 years in prison and a $1 million fine. Mr. Forbes is also accused of insider trading, relating to an $11 million stock sale he made about a month before the accounting irregularities were disclosed.

Both men have pleaded not guilty. Mr. Forbes's lawyer did not return a phone call requesting an interview. Mr. Shelton's lawyer said: "He is innocent and expects to be vindicated."

Thanks to the creative corporate minds at Enron, WorldCom, Tyco and Adelphia, investors are up to their necks in revelations of accounting shenanigans. But the scandal at Cendant still ranks as one of the world's costliest corporate calamities.

The day after the company disclosed evidence of accounting irregularities, holders of Cendant stock and convertible bonds lost more than $14 billion. And in 2000, Cendant, now based in New York, paid $2.85 billion to settle a securities suit filed by investors who had bought its stock. The company's auditor, Ernst & Young, paid $335 million to settle.

And the scandal is still costing Cendant. Under the company's bylaws, Mr. Forbes is entitled to reimbursement for his legal fees, which are running $1 million a month, according to court documents. The company can sue to recover the fees if Mr. Forbes is convicted.

Cendant has also sued Mr. Forbes to recover $35 million in cash and $12.5 million worth of stock options he received after he resigned from the company in July 1998.

Prosecutors have built their case against Mr. Forbes and Mr. Shelton with help from three former CUC financial executives who have pleaded guilty to fraud. The case has taken six years to reach the courtroom, in part because lawyers for Mr. Forbes and Mr. Shelton persuaded a judge to move the trial from New Jersey, where Cendant had been based, to Hartford, closer to Mr. Forbes's home in New Canaan, Conn., and Mr. Shelton's home in Darien, Conn.

Continued in article

"Judge Upholds Sarbanes-Oxley In Scrushy Fraud Case," AccounntingWeb, December 1, 2004 --- http://www.accountingweb.com/cgi-bin/item.cgi?id=100164 

Arguments that the Sarbanes-Oxley corporate reform law is unconstitutionally vague did not convince a federal judge, who has rejected Richard Scrushy's claims in his HealthSouth fraud case. Attorneys for Scrushy, HealthSouth's former chief executive, said the law should not be part of the indictment accusing him of fraud, the Associated Press reported. U.S. District Judge Karon O. Bowdre said jurors - not a judge - should decide central questions raised in the case.

"If the jury finds that the reports did not fairly present, in all material aspects, the financial condition and results of operations of HealthSouth, the jury must then determine whether Mr. Scrushy willingly certified these reports knowing that the reports did not comport with the statute's accuracy requirements," she wrote.

Continued in the article

"Scrushy Is Convicted in Bribery Case:   Prosecutors Savor Victory Over HealthSouth Ex-CEO After '05 Fraud Acquittal," by Valerie Bauerlein, The Wall Street Journal, June 30, 2006; Page A3 --- http://online.wsj.com/article/SB115160751950694468.html?mod=todays_us_page_one

HealthSouth Corp. founder Richard M. Scrushy was convicted of paying $500,000 in bribes in return for a spot on a state regulatory panel, a victory for the federal government a year and a day after it failed to pin a massive accounting fraud at the health-care company on him.

The guilty verdict on all six charges against the 53-year-old Mr. Scrushy, including bribery, conspiracy and mail fraud, could put him behind bars for as long as 20 years, though the judge has wide discretion on sentencing. Prosecutors and defense lawyers are likely to argue over how to weigh factors such as Mr. Scrushy's background and the size of the contributions for which he was convicted. Sentencing isn't expected until this fall at the earliest.

The Montgomery, Ala., jury also convicted former Alabama Gov. Don Siegelman on 10 political-corruption-related counts, six of them linked to Mr. Scrushy. During the two-month trial, prosecutors alleged that Mr. Scrushy arranged two hidden $250,000 payments to a lottery campaign backed by Mr. Siegelman, who put the then-chief executive of HealthSouth on a board that approves hospital-construction projects. The charges weren't related to the accounting fraud.

It wasn't clear what swayed jurors after 11 days of deliberation, or ended a deadlock that emerged last week. Mr. Scrushy's defense team clearly failed to win over the jury with its strategy of comparing him to civil-rights icons who suffered injustice. In his closing argument, Fred D. Gray, who represented Rosa Parks when she was arrested in 1955 for refusing to give up her seat on a Montgomery bus, quoted a favorite Biblical passage of Martin Luther King Jr., adding that an acquittal of Mr. Scrushy would mean that "justice will run down like water and righteousness as a mighty stream."

Federal prosecutors denounced the rhetoric as a racially motivated attempt to influence the jury of seven African-Americans and five whites, the same composition as the jury that acquitted Mr. Scrushy last year. They alleged that Mr. Scrushy had used his money and power to gain political influence that helped fuel HealthSouth's growth. Mr. Scrushy was forced out at HealthSouth when the accounting fraud surfaced in 2003.

Charlie Russell, a spokesman for Mr. Scrushy, said the former HealthSouth CEO was "shocked" by his conviction. "He maintains that he is absolutely innocent, and he intends to appeal." Before the trial, Mr. Scrushy's lawyers fought unsuccessfully to have him tried separately and objected to the makeup of the jury pool.

In a statement, Louis V. Franklin Sr., criminal-division chief of the U.S. attorney's office in Montgomery, said the verdict "sends a clear message that the integrity of Alabama's government is not for sale." HealthSouth said Mr. Scrushy's conviction "has no impact on the company," which continues to pursue a turnaround strategy under new management. HealthSouth has filed a lawsuit against him in connection with the fraud, while Mr. Scrushy has sued the company for wrongful termination and breach of contract, citing his acquittal in last year's trial. Mr. Scrushy also faces fraud-related civil lawsuits filed by shareholders and the Securities and Exchange Commission.

Doug Jones, a former U.S. attorney now representing HealthSouth shareholders in a suit against Mr. Scrushy, said the verdict could help plaintiffs in the remaining cases because Mr. Scrushy likely will be forced to answer questions about his conviction. Sean Coffey, a lawyer representing bondholders, added, "Even though it's not directly related, the folks we represent can't see enough hurt get on that guy."

Jurors acquitted the two other defendants, Paul Hamrick, a onetime chief of staff to the former governor, and Gary Roberts, former head of the Alabama transportation department.

Bob Jensen's threads on the HealthSouth scandals are at http://www.trinity.edu/rjensen/Fraud001.htm#Ernst

The HealthSouth Settlement Does Not Include Ernst & Young

From The Wall Street Journal Accounting Weekly Review on November 10, 2006

TITLE: UnitedHealth Expects Probe to Result in 'Greater' Charges
REPORTER: Steve Stecklow and Vanessa Fuhrmans
DATE: Nov 09, 2006
PAGE: B1
LINK: http://online.wsj.com/article/SB116299996219517252.html?mod=djem_jiewr_ac 
TOPICS: Accounting, Accounting Changes and Error Corrections, Sarbanes-Oxley Act, Securities and Exchange Commission, Stock Options

SUMMARY: "UnitedHealth Group Inc. said it would have to take charges related to its backdated stock options that will be 'significantly greater' than its previous estimates and expects the charges to impact more than 10 years of previously reported earnings."

QUESTIONS:
1.) Describe the options backdating scandal that has developed since March, 2006. If you are unfamiliar with the issue, you may click on the link for "Perfect Payday: Complete coverage" on the left hand side of the on-line article.

2.) For how long has options backdating been going on at UnitedHealth? Have the accounting requirements remained the same throughout that period of time? Summarize the required accounting and other financial reporting practices for executive and employee stock options over the last 10 years.

3.) Suppose that, once UnitedHealth finishes its review, the restatement of earnings nearly doubles to $500 million and that the restatement applies equally to each of the preceding 10 years. What accounting entry must be made to correct this $500 million error? What will be the ultimate impact on each year's earnings and on stockholders' equity at the end of each year? How will this correction be disclosed? In your answer, cite the accounting standards which require the treatment you present.

4.) Click on "Read the full text" of UnitedHealth's Nov. 8 filing with the SEC on the right-hand side of the on-line article. What Form number did UnitedHealth file? Summarize the implications of the depth of the options backdating problem found at this company.

5.) Refer to the related article. What role does the Public Accounting Oversight Board fill in assisting accountants to audit companies' accounting for stock options?

Reviewed By: Judy Beckman, University of Rhode Island

--- RELATED ARTICLES ---
TITLE: Guidelines Set for How to Audit Stock Options
REPORTER: Siobhan Hughes
PAGE: A10 ISSUE: Oct 18, 2006
LINK: http://online.wsj.com/article/SB116114078518696161.html?mod=djem_jiewr_ac

"HealthSouth Agrees to $445 Million Settlement," AccountingWeb, October 2, 2006 ---
http://www.accountingweb.com/cgi-bin/item.cgi?id=102629

HealthSouth Corp. announced on Wednesday that it will pay $445 million to settle several lawsuits that were filed against the company and some of its former directors after an accounting scandal.

HealthSouth will pay $215 million in common stock and warrants, and its insurance carriers will pay $230 million in cash, the company said. Also, federal securities class-action plaintiffs will get 25 percent of any future judgments obtained by or on behalf of HealthSouth regarding certain claims against fired CEO Richard Scrushy, former auditors Ernst & Young, and the company’s former investment bank, UBS. Each party remains a defendant in the derivative actions and the federal securities class actions.

A judge must approve the settlement, which is nearly the same as a preliminary settlement that was reached in February.

"This settlement represents another significant milestone in HealthSouth's recovery and is a powerful symbol of the progress we have made as a company," said HealthSouth President and CEO Jay Grinney. HealthSouth, the Birmingham, Ala.-based rehabilitation and medical services chain, does not admit any wrongdoing in the settlement, nor does any other settling defendant, the company said.

The settlement does not include Ernst & Young, UBS, Scrushy or any former HealthSouth officer who entered a guilty plea or was convicted of a crime in connection with the company's financial reporting activities ending in March 2003.

Scrushy and more than a dozen top executives were accused of recording as much as $2.7 billion in bogus revenues on the company's books over six years. UBS and Ernst & Young have denied knowing about the fraud. Last year, Scrushy was acquitted of all criminal charges in the fraud. He was convicted of conspiracy, bribery and mail fraud charges in a separate government corruption trial.

Risk-Based Auditing Under Attack

Bob Jensen's threads about troubles in the large accounting firms are at http://www.trinity.edu/rjensen/Fraud001.htm#others

Bob Jensen’s threads on the future of auditing are at
 http://www.trinity.edu/rjensen/FraudConclusion.htm#FutureOfAuditing

Auditors looking into the fraud at HealthSouth have found it to be far more extensive than originally thought-as much as $4.6 billion in all. Initially, estimates put the fraud at $3.5 billion at the Birmingham, AL-based operator of rehabilitative clinics.  The auditing firm implicated in the HealthSouth scandal is Ernst & Young --- http://www.AccountingWEB.com/cgi-bin/item.cgi?id=98609 

"Ernst & Young Faces Informal SEC Inquiry Of Consultant's Pay," by Joann S. Lublin and Johathan Weil, The Wall Street Journal, June 8, 2004, Page C1 --- http://online.wsj.com/article/0,,SB108664493445730875,00.html?mod=home_whats_news_us 

Ernst & Young LLP hoped the $377,500 it paid a marketing consultant would deliver results. It did -- only not the sort it wanted.

The Securities and Exchange Commission has begun an informal inquiry into whether the money paid to the consultant impaired the accounting firm's independence as an outside auditor at three companies: executive-search firm Korn/Ferry International, big-box retailer Best Buy Co. and TeleTech Holdings Inc., which runs telephone call centers. The "leadership development" consultant, Mark C. Thompson, was sitting on the boards of the three companies while working for Ernst & Young.

News of the SEC's inquiry comes less than two months after the commission barred Ernst from accepting new audit clients for six months because of auditor-independence violations at former audit client PeopleSoft Inc. The SEC criticized Ernst in that case for not having sufficient internal procedures to guard against such violations.

Unlike the PeopleSoft case, which involved nearly $500 million of revenue that Ernst received from the software maker, the latest inquiry focuses on much-smaller payments made by Ernst itself. Those payments were made from December 2002 through April 2004, ending at about the time of the suspension handed down by an SEC administrative-law judge in the PeopleSoft matter.

Whether the payments by Ernst constituted an auditor-independence violation will hinge on whether the agency determines that the firm made them as a consumer in the ordinary course of business, which is the only exception to the SEC's general rule that auditors not enter into business relationships with audit clients.

Continued in article

"Behind Wave of Corporate Fraud: A Change in How Auditors Work:  'Risk Based' Model Narrowed Focus of Their Procedures, Leaving Room for Trouble,' " by Jonathan Weil, The Wall Street Journal, March 25, 2004, Page A1

The recent wave of corporate fraud is raising a harsh question about the auditors who review and bless companies' financial results: How could they have missed all the wrongdoing? One little-discussed answer: a big change in the way audits are performed.

Consider what happened when James Lamphron and his team of Ernst & Young LLP accountants sat down early last year to plan their audit of HealthSouth Corp.'s 2002 financial statements. When they asked executives of the Birmingham, Ala., hospital chain if they were aware of any significant instances of fraud, the executives replied no. In their planning papers, the auditors wrote that HealthSouth's system for generating financial data was reliable, the company's executives were ethical, and that HealthSouth's management had "designed an environment for success."

As a result, the auditors performed far fewer tests of the numbers on the company's books than they would have at an audit client where they perceived the risk of accounting fraud to be higher. That's standard practice under the "risk-based audit" approach now used widely throughout the accounting profession. Among the items the Ernst & Young auditors didn't examine at all: additions of less than $5,000 to individual assets on the company's ledger.

Those numbers are where HealthSouth executives hid a big part of a giant fraud. This blind spot in the firm's auditing procedures is a key reason why former HealthSouth executives, 15 of whom have pleaded guilty to fraud charges, were able to overstate profits by $3 billion without anyone from Ernst & Young noticing until March 2003, when federal agents began making arrests.

A look at the risk-based approach also helps explain why investors continue to be socked by accounting scandals, from WorldCom Inc. and Tyco International Ltd. to Parmalat SpA, the Italian dairy company that admitted faking $4.8 billion in cash. Just because an accounting firm says it has audited a company's numbers doesn't mean it actually has checked them.

In a September 2003 speech, Daniel Goelzer, a member of the auditing profession's new regulator, the Public Company Accounting Oversight Board, called the risk-based approach one of the key factors "that seem to have contributed to the erosion of trust in auditing." Faced with difficulty in raising audit fees, Mr. Goelzer said, the major accounting firms during the 1990s began to stress cost controls. And they began to place greater emphasis on planning the scope of their work based on auditors' judgments about which clients are risky and which areas of a company's financial reports are most prone to error or fraud.

Auditors still plow through "high risk" items, such as derivative financial instruments or "related party" business dealings between a company and its executives. But ostensibly "low risk" items -- such as cash on the balance sheet or accounts that fluctuate little from year to year -- often get no more than a cursory review, for years at a stretch. Instead, auditors rely more heavily on what management tells them and the auditors' assessments of a company's "internal controls."

Old and New

A 2001 brochure by KPMG LLP, which claims to have pioneered the risk-based audit during the early 1990s, explained the difference between the old and new ways. Under a traditional "bottom up" audit, "the auditor gains assurance by examining all of the component parts of the financial statements, ensuring that the transactions recorded are complete and accurate." By comparison, under the "top down" risk-based audit methodology, auditors focus "less on the details of individual transactions" and use their knowledge of a company's business and organization "to identify risks that could affect the financial statements and to target audit effort in those areas."

So, for instance, if controls over a company's sales and customer IOUs are perceived to be strong, the auditor might mail out only a limited number of confirmation requests to companies that do business with the audit client at the end of the year. Instead, the auditor would rely more on the numbers spit out by the company's computers.

For inventory, the lower the perceived risk of errors or fraud, the less frequently junior-level accountants might be dispatched on surprise visits to a client's warehouses to oversee the company's procedures for counting unsold goods. If cash and securities on the balance sheet are deemed low risk, the auditor might mail out only a relative handful of confirmation requests to a company's banks or brokerage firms.

In theory, the risk-based approach should work fine, if an auditor is good at identifying the areas where misstatements are most likely to occur. Proponents advocate the shift as a cost-efficient improvement. They also say it forces auditors to pay needed attention to areas that are more subjective or complex.

"The problem is that there's not a lot of evidence that auditors are very good at assessing risk," says Charles Cullinan, an accounting professor at Bryant College in Smithfield, R.I., and co-author of a 2002 study that criticized the re-engineered audit process as ineffective at detecting fraud. "If you assess risk as low, and it really isn't low, you really could be missing the critical issues in the audit."

Auditors can't check all of a company's numbers, since that would make audits too expensive, particularly in an age of sprawling multinationals. The tools at auditors' disposal can't ensure the reliability of a company's numbers with absolute certainty. And in many ways, they haven't changed much over the modern industry's 160-year history.

Auditors scan the accounting records for inconsistencies. They ask people questions. That can mean independently contacting a client's customers to make sure they haven't struck undocumented side deals -- such as agreeing to buy more products today in exchange for a salesperson's oral promises of future discounts. They search for unrecorded liabilities by tracing cash disbursements to make sure the obligations are recorded properly. They examine invoices and the terms of sales contracts to check if a company is recording revenue prematurely.

Auditors are supposed to avoid becoming predictable. Otherwise, a client's management might figure out how to sneak things by them. It's also important to sample-test tiny accounting entries, even as low as a couple of hundred dollars. An old accounting trick is to fudge lots of tiny entries that appear insignificant individually but materially distort a company's financial statements when taken together.

Facing a crush of shareholder lawsuits over the accounting scandals of the past four years, the Big Four accounting firms say they are pouring tens of millions of dollars into improving their auditing techniques. KPMG's investigative division has doubled to 280 its force of forensic specialists, some hailing from the Federal Bureau of Investigation. PricewaterhouseCoopers LLP auditors attend seminars run by former Central Intelligence Agency operatives on how to spot deceitful managers by scrutinizing body language and verbal cues. Role-playing exercises teach how to stand up to a company's management.

But the firms aren't backing away from the concept of the risk-based audit itself. "It would really be negligent" not to take a risk-based approach, says Greg Weaver, head of Deloitte & Touche LLP's U.S. audit practice. Auditors need to "understand the areas that are likely to be more subject to error," he says. "Some might believe that if you cover those high-risk areas, you could do less work in other areas." But, he adds, "I don't think that's been a problem at Deloitte."

Mr. Lamphron, the Ernst & Young partner, and his firm blame HealthSouth's former executives for deceiving them. Mr. Lamphron declined to comment for this article. Testifying before a congressional subcommittee in November, he said he had looked through his audit papers and "tried to find that one string that, had we yanked it, would have unraveled this fraud. I know we planned and conducted a solid audit. We asked the right questions. We sought out the right documentation. Had we asked for additional documentation here or asked another question there, I think that it would have generated another false document and another lie."

The pioneers of the auditing industry had a more can-do spirit. In Britain during the 1840s, William Deloitte, whose firm continues today as Deloitte & Touche, made a name for himself by helping to unravel frauds at the Great Eastern Steamship Co. and Great Northern Railway. A growing breed of professionals such as William Cooper, whose name lives on in PricewaterhouseCoopers, began advertising their services as an essential means for rooting out fraud.

"The auditor who is able to detect fraud is -- other things being equal -- a better man than the auditor who cannot," wrote influential British accountant Lawrence Dicksee in his 1892 book, "Auditing," one of the earliest on the subject.

But in the U.S., the notion of the auditor as detective never quite took off. The Securities and Exchange Commission in the 1930s made audits mandatory for public companies. The auditing profession faced its first real public test in 1937, when an accounting scandal broke open at McKesson & Robbins: More than 20% of the assets reported by the drug company were fictitious inventory and customer IOUs. The auditors had been fooled by forged documents.

The case triggered some reforms. Auditing standards began requiring that auditors perform more substantive tests, such as contacting third parties to confirm customer IOUs and physically inspecting clients' warehouses to check inventories. However, the American Institute of Certified Public Accountants, the group that set auditing standards, repeatedly emphasized the limitations on auditors' ability to detect fraud, fearing liability exposure for its members.

By the 1970s, a new force emerged to erode audit quality: price competition. For decades, the AICPA had barred auditors from publicly advertising their services, making uninvited solicitations to rival firms' clients or participating in competitive-bidding contests. The institute was forced to lift those bans, however, when the federal government deemed them anticompetitive and threatened to bring antitrust lawsuits.

Bidding wars ensued. The pressures to hold down hours on a job "inadvertently discouraged auditors to look for" fraud, says Toby Bishop, president of the Association of Certified Fraud Examiners, a professional association.

Increasingly, audits became a commodity product. Flat-fee pricing became common. The big accounting firms spent much of the 1980s and 1990s building more-lucrative consulting operations. Many audit clients soon were paying their independent accounting firms far more money for consulting than auditing. The audit had become a mere foot in the door for the consultants. Economic pressures also brought a wave of mergers, winnowing down the number of accounting firms just as the number of publicly traded companies was exploding and corporate financial statements were becoming more complex.

Even before the recent rash of accounting scandals, the shift away from extensive line-by-line number crunching was drawing criticism. In an October 1999 speech, Lynn Turner, then the SEC's chief accountant, noted that more than 80% of the agency's accounting-fraud cases from 1987 to 1997 involved top executives. While the risk-based approach was focusing on information systems and the employees who fed them, auditors really needed to expand their scrutiny to include top executives, who with a few keystrokes could override their companies' systems.

Looking back, the risk-based approach's flaws are on display at a variety of accounting scandals, from WorldCom to Tyco to HealthSouth.

When WorldCom was a small, start-up telecommunications company, its outside auditor, Arthur Andersen LLP, did things the old-fashioned way. It tested the thousands of details of individual transactions, and it reviewed and confirmed the items in WorldCom's general ledger, where the company's accounting entries were first logged.

But as WorldCom grew, Andersen shifted toward what it called a risk-based "business audit process." By 1998, it was incurring more costs to audit WorldCom than it was billing, making up the difference with fees for consulting and other work, according to an investigative report last year by WorldCom's audit committee. In its 2000 audit proposal to WorldCom, Andersen said it considered itself "a committed member of [WorldCom's] team" and saw the company as a "flagship client and a crown jewel" of the firm.

Under the revised audit approach, Andersen used sophisticated software to analyze WorldCom's financial statements. The auditors gathered for brainstorming sessions, imagining ways WorldCom might cook its books. After identifying areas of high risk, the auditors checked the adequacy of internal controls in those areas by reviewing the company's procedures, discussing them with some employees and performing sample tests to see if the procedures were followed.

'Maximum Risk'

When questions arose, the auditors relied on the answers supplied by management, even though their software had rated WorldCom a "maximum risk" client, according to a January report by WorldCom's bankruptcy examiner, former U.S. Attorney General Richard Thornburgh.

One question that Andersen auditors routinely asked WorldCom management was whether they had made any "top side" adjustments -- meaning unusual accounting entries in a company's general ledger that are recorded after the books for a given quarter had closed. Each year, from 1999 through 2002, WorldCom management told the auditors they hadn't. According to Mr. Thornburgh's report, the auditors conducted no testing to corroborate if that was true.

They did check to see if there were any major swings in the items on the company's consolidated balance sheet. There weren't any, and from this, the auditors concluded that follow-up procedures weren't necessary. Indeed, WorldCom executives had manipulated its numbers so there wouldn't be any unusual variances.

Had the auditors dug into specific journal entries -- the debits and credits that are the initial entries of transactions or events into a company's accounting systems -- they would have seen hundreds of huge entries of suspiciously round numbers that had no supporting documentation.

The sole documentation for one $239 million journal entry, recorded after the close of the 1999 fourth quarter, was a sticky note bearing the number "$239,000,000," according to the WorldCom audit committee's report. Sometimes the "top side" adjustments boosted earnings by reversing liabilities. Other times they reclassified ordinary expenses as assets, which delayed recognition of costs. Other unsupported journal entries included one for precisely $334 million in July 2000, three weeks after the second quarter's books were closed. Another was for exactly $560 million in July 2001.

Andersen signed its last audit report for WorldCom in March 2002, saying the numbers were clean. Three months later, WorldCom announced that top executives, including its former chief financial officer, had improperly classified billions of dollars of ordinary expenses as assets. The final tally of fraudulent profits hit $10.6 billion. WorldCom filed for Chapter 11 reorganization in June 2002, marking the largest bankruptcy in U.S. history. Now out of business, Andersen is appealing its June 2002 felony conviction for obstruction of justice in connection with its botched audits of Enron Corp.

"No matter what kind of audit you do, it is virtually impossible for an auditor to detect purposeful fraud by management," says Patrick Dorton, an Andersen spokesman. "And that's exactly what happened at WorldCom."

PricewaterhouseCoopers also fell prone to faulty risk assessments. In July, the SEC forced Tyco, the industrial conglomerate, to restate its profits, which it inflated by $1.15 billion, pretax, from 1998 to 2001. The next month, the SEC barred the lead partner on the firm's Tyco audits from auditing publicly registered companies. His alleged offense: fraudulently representing to investors that his firm had conducted a proper audit. The SEC in its complaint said that the auditor, Richard Scalzo, who settled without admitting or denying the allegations, saw warning signs about top Tyco executives' integrity but never expanded his team's audit procedures.

Mr. Scalzo declined to comment. A PricewaterhouseCoopers spokesman declined to comment on the SEC's findings in the Tyco matter.

Like Tyco and WorldCom, HealthSouth grew mainly by buying other companies, using its own shares as currency. So it needed to keep its stock price up. To do that, the company admitted last year, it faked its profits.

In their audit-planning papers, Ernst & Young auditors noted HealthSouth executives' "excessive interest" in maintaining or increasing its stock price and earnings. Twice since the 1990s, the Justice Department had filed Medicare-fraud suits against HealthSouth.

But none of that shook the Ernst & Young audit team's confidence in management's integrity, members of the team later testified. And at little more than $1 million annually, Ernst & Young's audits were fairly low cost. The firm charged slightly less to audit HealthSouth's financial statements than it did for one of its other services for HealthSouth: performing janitorial inspections of the company's 1,800 health-care facilities. The inspections, performed by junior-level accountants armed with 50-point checklists, included checking to see that the toilets and ceilings were free of stains, the magazine racks were neat and orderly, and the trash receptacles all had liners.

Most of HealthSouth's fraud occurred in an account called "contractual adjustments." This is an allowance on the income statement that estimates the difference between the gross amount charged to a patient and the amount that various insurers, including Medicare, will pay for a specific treatment. The company manipulated the account to make net revenue and bottom-line earnings look higher. But for every dollar of illicit revenue, HealthSouth executives had to make a corresponding entry on the balance sheet, where the company listed its assets and liabilities.

An Ernst & Young spokesman, Charlie Perkins, says the firm "performed appropriate procedures" on the contractual-adjustment account.

At an April 2003 court hearing, Ernst & Young auditor William Curtis Miller testified that his team mainly had performed "analytical type procedures" on the contractual adjustments. These consisted of mathematical calculations to see if the account had fluctuated sharply overall, which it hadn't. As for the balance-sheet entries, prosecutors say HealthSouth executives knew the auditors didn't look at increases of less than $5,000, a point Ernst & Young acknowledges. So the executives broke up the entries into tiny pieces, sprinkling them across lots of assets.

The company's ledger showed thousands of unusual journal entries that reclassified everyday expenses -- such as gasoline and auto-service bills -- as assets. Had the auditors seen those items, one congresswoman noted at a November hearing, they would have spotted that something was wrong. Mr. Lamphron conceded her point.

March 27, 2004 reply from MacEwan Wright, Victoria University [Mac.Wright@VU.EDU.AU] 

-----Original Message----- 
From:  
Sent: Saturday, March 27, 2004 10:29 PM 
Subject: Re: Attacks on Risk-Based Auditing

Dear Bob, 

I wonder if this is not a case of throwing the baby out with the bathwater. I mean the idea of risk based auditing is not in itself a bad idea, The problem is that the idea of what constitutes risk is not properly understood. As I interpret it - risk means probability of event multiplied by cost of event. Risk as used in audit planning means probability of event. It is obvious that the team did not do enough to properly evaluate the inherent risk or more properly stated - the probability that management wouold lie and cheat for profit.

It is am American attitude problem. An American executive posted to an Australian company found the amount of work put into finding out how honest potential employees were a waste of time - "just bond them and sack them and claim the bond insurance if they cheat". Bonding is virtually unheard of in Australia.

I feel that attitude may encourage fraud - the game is what can each party get away with!

Sorry about the social implications. 

Kind regards, 

Mac Wright

March 27, 2004 reply from Bob Jensen

Hi Mac,

You are correct about the fact that risk-based auditing has led to game playing. Somehow the HealthSouth executives figured out that the risk of getting caught with fraudulent transactions under $6,000 each was nearly zero under their auditor's (E&Y) risk-based model, so they looted the company with transactions under $6,000 each.

I agree with you that some form of risk-based auditing should be utilized.  I think this was the case long before KPMG formalized the concept.  However, in addition the fear of detailed testing of small transactions must still remain high among client employees. Auditors must invest more in unpredictable detailed testing up to a point where the probability of being audited for even small transactions is significant.

Probably the worst-case scenario that virtually eliminated fear of getting caught was Andersen's notoriously defective audits of Worldcom. I'm told (rumor mill) that an Andersen auditor had not even been seen in Worldcom's purchasing department for a number of years. What is the first department an auditor should investigate for fraud?

Bob

March 28, 2004 reply from Glen L Gray [vcact00f@CSUN.EDU]

I know a treasurer of a major company. It used to bug him that the auditors came by every year and take up her staff's time collecting & reconciling bank and investment information. Then a few years ago, they just stopped showing up in the treasury dept. I've always wondered what the auditor's risk model was if suddenly cash and investments were no longer important.

A Little Like Dirty Pooling Accounting
Tyco Undervalues Acquired Assets and Overvalues Acquired Liabilities: 
Tyco International Ltd. said Monday it has agreed to pay the Securities and Exchange Commission $50 million to settle charges related to allegations of accounting fraud by the high-tech conglomerate's prior management. The regulatory agency had accused Tyco of inflating operating earnings, undervaluing acquired assets, overvaluing acquired liabilities and using improper accounting rules, company spokeswoman Sheri Woodruff said. 'The accounting practices violated federal securities laws,'' she said.
"Tyco to Pay S.E.C. $50 Million on Accounting Charges," The New York Times, April 17, 2006 --- http://www.nytimes.com/aponline/business/AP-Tyco-SEC-Fine.html?_r=1&oref=slogin

April 17, 2006 reply from Saeed Roohani

Bob,

Assuming improper accounting practices by Tyco negatively impacted investors and creditors in the capital markets, why SEC gets the $50 M? Shouldn't SEC give at least some of it back to the people potentially hurt by such practices? Or damage to investors should only come from auditors' pocket?

Saeed Roohani

April 18, 2006 reply from Bob Jensen

Hi Saeed,

In a case like this it is difficult to identify particular victims and the extent of the damage of this one small set of accounting misdeeds in the complex and interactive multivariate world of information.

The damage is also highly dispersed even if you confine the scope to just existing shareholders in Tyco at the particular time of the financial reports.

One has to look at motives. I'm guessing that one motive was to provide overstated future ROIs from acquisitions in order to justify the huge compensation packages that the CEO (Kozlowski) and the CFO (Schwarz) were requesting from Tyco's Board of Directors for superior acquisition performance. Suppose that they got $125 million extra in compensation. The amount of damage for to each shareholder for each share of stock is rather minor since there were so many shares outstanding.

Also, in spite of the illegal accounting, Kozlowski's acquisitions were and still are darn profitable for Tyco. I have a close friend (and neighbor) in New Hampshire, a former NH State Trooper, who became Koslowski's personal body guard. To this day my friend, Jack, swears that Kozlowski did a great job for Tyco in spite of possibly "stealing" some of Tyco's money. Many shareholders wish Kozlowski was still in command even if he did steal a small portion of the huge amount he made for Tyco. He had a skill at negotiating some great acquisition deals in spite of trying to take a bit more credit for the future ROIs than was justified under purchase accounting instead of virtual pooling accounting.

I actually think Dennis Kozlowski was simply trying to get a bit larger commission (than authorized by the Board) for some of his good acquisition deals.

Would you rather have a smart crook or an unimaginative bean counter managing your company? (Just kidding)

Bob Jensen

"Tyco Investors Get Ripped Off Again ... This Time by the SEC," by J. Edward Ketz, SmartPros, May 2006 --- http://accounting.smartpros.com/x52777.xml

On April 17, 2006, the Securities and Exchange Commission issued Litigation Release No. 19657, which states that the SEC and Tyco have settled terms over this fraud. In its civil complaint, the SEC alleges that Tyco undervalued assets and overvalued liabilities acquired in business combinations, inflated operating income and cash flows from operating activities, and bribed foreign officials in Brazil. The SEC also contends that Tyco covered up these activities with false and misleading financial reports. In the usual fashion of these decrees, Tyco neither admits nor denies the charges; nevertheless, it consents to the judgment. In this case, Tyco must pay a $50 million penalty.

But, just a minute! Who is really paying this $50 million fine? It's not management, neither Kozlowski nor Schwartz (the SEC continues its investigation of them, and they may receive additional fines), nor Tyco's present management team. The board of directors is not paying the fine either. Given the firm itself is paying this ticket, it implies that the real payers are the investors of Tyco, who in effect must cough up $50,000,000. So this raises the question -- why should the investors get ripped off twice?

Let's go back to basics: civil penalties and criminal sentences serve two purposes in our society. First, they satisfy, however partially, our collective sense of justice. Kozlowski and Schwartz defrauded many investors, and these aggrieved investors seek justice, but they seek justice against the perpetrators of the conspirators, not the victims. Not themselves. Second, society issues civil penalties and criminal sentences to deter future crimes. The idea is that if the disincentives are sufficiently obnoxious and if the probably of enforcement is sufficiently high, then future managers are less likely to follow suit with their own crimes against investors. In this case too, the argument is persuasive as long as the courts levy fines and punishment against the malefactors and not against the victims.

The SEC has for a long time engaged in these civil judgments against firms that have experienced accounting and securities fraud. It would do well for the SEC to re-examine this policy, realize that its effects are pernicious and counterproductive, and then repeal the strategy. It is silly for the investors to suffer for the wrongdoing by corporate thieves masquerading as managers.

As an aside, the reader may remember the infamous committee headed by David Boies, on behalf of Tyco's board of directors, to examine the Tyco situation and determine whether Tyco had engaged in an accounting scam. Tyco issued this report in an 8-K filed on December 30, 2002. That committee kept its eyes closed and found that "there was no significant or systemic fraud." I wonder what excuse David Boies or the other members of the committee could provide today for their wanting analysis.

If the SEC really desires to deter future accounting frauds, it must align its punishment with the scoundrels who carry out these misdeeds. The SEC also must enforce the securities laws to the fullest extent possible. If today's managers see other managers hauled off to prison or paying huge fines, they will be less apt to steal from and cheat investors. If today's managers see the corporation fined and thus feel little or no impact themselves, well, the firm becomes one's personal piggy bank.

Bob Jensen's summary of proposed auditing reforms is at http://www.trinity.edu/rjensen/FraudProposedReforms.htm

"Adelphia's 'Accounting Magic' Fooled Auditors, Witness Says<" by Christine Nuzum, The Wall Street Journal, May 5, 2004 --- http://online.wsj.com/article/0,,SB108369959478101710,00.html?mod=technology_main_whats_news

Adelphia Communications Corp. revealed its real results and its publicly reported inflated numbers in the books given to many employees, including founder John Rigas and two of his sons, a former executive testified.

But these financial statements, detailing actual numbers and phony ones dating back to 1997, weren't disclosed to the company's auditors, Deloitte & Touche, said former Vice President of Finance James Brown in his second day on the stand. Former Chief Financial Officer Timothy Rigas supported the system to keep employees aware of the company's real performance, Mr. Brown testified.

For example, one internal document showed that while Adelphia's operating cash flow was $177 million for the quarter ended in September 1997, its publicly reported operating cash flow was $228 million, Mr. Brown said.

Mr. Brown has pleaded guilty in the case and is testifying in hopes of receiving a reduced sentence.

John Rigas, his sons Timothy Rigas and former Executive Vice President Michael Rigas, and former Assistant Treasurer Michael Mulcahey are on trial here on charges of conspiracy and fraud. Michael Rigas was back in court yesterday, one day after court was canceled due to a medical issue that sent him to the hospital over the weekend. People close to the case said the problem was minor.

Mr. Brown said he devised various schemes to inflate Adelphia's publicly reported financial measures. Company executives were afraid that if Adelphia's true performance was revealed, the company would be found in default of credit agreements, he said. "I used the term 'accounting magic,' " Mr. Brown said.

In March 2001, phony documents dated 1999 and 2000 were created "to fool the auditors into believing that they were real economic transactions," he testified.

Mr. Brown discussed the details of how to inflate Adelphia's financial measures with Timothy Rigas more than the other defendants, but John Rigas and Michael Rigas also knew that the company's public filings didn't represent its real performance, he testified. John Rigas occasionally showed discomfort with the inflation, but did nothing to stop it, Mr. Brown said.

Mr. Brown testified he used to regularly tell John Rigas Adelphia's real results and how they compared with those of other cable companies. "On one occasion John told me, 'We need to get away from this accounting magic,' " he recalled. Mr. Brown added that he understood that to mean that Adelphia needed to boost its operations so that at some point in the future, the inflation could stop.

In another discussion about inflated numbers in early 2001, John Rigas "told me he felt sorry for Tim Rigas and me because the operating results were putting so much pressure on us ... but he said, 'You have to do what you have to do,' " Mr. Brown testified. "He also said we can't afford to have a default." Mr. Brown said he took that to mean that reporting inflated numbers was preferable to defaulting.

Andersen's David Duncan is not the only Big Four partner arrested for destroying audit work papers.
"Former Partner at Ernst Is Arrested," by Cassell Bryan-Low and Jonathan Weil, The Wall Street Journal, September 26, 2003 --- http://online.wsj.com/article/0,,SB106451287418543900,00.html?mod=mkts_main_news_hs_h

Federal agents arrested a former Ernst & Young LLP audit partner on criminal charges of obstruction of justice, in one of the first cases of alleged document destruction brought under the 14-month-old Sarbanes-Oxley Act.

The U.S. Attorney's Office for the Northern District of California alleged that the former partner obstructed an examination by federal-bank regulators, and later by securities regulators, into NextCard Inc., an Internet-based credit-card issuer, by destroying work papers from its audits of the company. The auditor, prosecutors alleged, altered and deleted documents to make it appear that Ernst & Young had thoroughly considered key financial issues at the San Francisco company.

Another former E&Y employee has pleaded guilty to a criminal-obstruction charge in connection with the matter, while a third faces civil-administrative proceedings brought by the Securities and Exchange Commission.

In a statement, E&Y said that it had contacted federal authorities when it first became aware of "the violation" and also launched an internal probe. All three employees are no longer with the firm as a result of the investigation, E&Y said, and the firm is co-operating with various governmental agencies. Ed Swanson, a lawyers for the former partner, Thomas C. Trauger, 40 years old, said that his client intends to pleas not guilty and to fight the charges. "Tom is a good man and well-respected accountant and I am confident he will be exonerated," said Mr. Swanson.

Federal officials noted the investigation continues, leaving open the possibility that E&Y itself could be charged. But some accounting and legal specialists noted significant differences between the E&Y matter and the case against Arthur Andersen LLP that led to its swift downfall.

Most notably, Andersen already was on a probation of sorts with the SEC when its auditors shredded thousands of pages of documents tied to its Enron Corp. audits; E&Y isn't under any similar probation. To date, no indication has surfaced that the alleged criminal conduct at E&Y reached beyond the former auditor and the two other former Ernst employees.

The legal action takes advantage of "additional tools" provided by last year's sweeping securities reform, Sarbanes Oxley, "to aggressively prosecute this kind of conduct," said Ross Nadel, head of the criminal division in the U.S. Attorney's Office in San Francisco. Specifically, the act gives prosecutors more leeway in prosecuting those who seek to destroy, alter or falsify financial information and records.

Continued in the article.

Ernst & Young in Trouble With the SEC

SEC seeks sanctions against Ernst and Young

By Joshua Chaffin in Washington

Published: New York Times, May 29 2003

Ernst & Young, one of the world's largest auditing firms, faces a six-month ban from taking on new public company auditing clients following a Securities and Exchange Commission investigation. The SEC, the chief US financial regulator, has asked an executive judge for the temporary ban and other sanctions against E&Y to remedy claims that the firm compromised its independence with respect to one of its clients, PeopleSoft, the software maker. Ernst & Young has denied the SEC's claims, and called its recommendations "irresponsible". The judge is not likely to rule on the case for months. Nonetheless, the severity of the proposed penalties reflect the SEC's effort to stop abuses in an accounting industry that has featured prominently in corporate scandals at Enron and other US companies. The SEC has requested the temporary auditing ban only a few times in the last 20 years. The SEC ruled out an outright ban on audits at E&Y out of fear that it would unfairly punish the firm's corporate clients, observers say. Such a measure might also have jeopardised the firm's existence. The US accounting sector has already been pared from five to four large firms with the dissolution of Andersen. The SEC accused E&Y of compromising its independence as PeopleSoft's auditor by entering into two side arrangements with the software maker. In one case, E&Y sold a PeopleSoft software programme used to calculate taxes for overseas employees. In another, E&Y installed PeopleSoft's products for corporate customers, according to the SEC. That arrangement netted E&Y $452m in fees from 1995 to 1999. In addition to the ban, the SEC is also seeking the disgorgement of $1.7m in audting fees from E&Y and the appointment of an independent officer to review the firm's auditing independence. The requests, filed with the court last week, were first reported by The Washington Post. E&Y said it was "confident that the firm in no way violated the independence rules and there is no basis for the imposition of any sanctions of any sort against the Firm."

October 17, 2003 message from Clikeman, Paul [pclikema@RICHMOND.EDU] 

60 Minutes is going to air a report this Sunday about accounting firms' promotion of "abusive" tax shelters. The synopsis from the CBS web site is below. Also, they apparently aired an interview with HealthSouth CEO Richard Scrushy last week. Did anybody see that episode and was it any good?

Gimme Shelter Oct. 17, 2003

The tax shelters the rich use to avoid an estimated $50 billion in taxes a year are the "schemes" of reputable accounting and law firms that profit immensely by selling them to their clients, says Sen. Charles Grassley (R-Iowa), chairman of the Senate Finance Committee.

He appears in Steve Kroft's report on abusive tax shelters to be broadcast on 60 Minutes, Sunday, Oct. 19, at 7 p.m. ET/PT.

"The source of the problem is the accounting firms and the law firms that peddle these schemes," says Grassley of the tax shelters, which are usually rejected by courts and the Internal Revenue Service. "You just can't write tax laws precisely enough to avoid the ingenuity of lawyers and accountants."

The "schemes" put a taxable income through elaborate financial transactions that create artificial losses to offset that income. "The products they're selling generally don't work," says Stanford University law professor Joseph Bankman, a tax shelter expert.

"If it's not illegal... it's certainly somewhat unethical, I think," says Bankman. Competitive pressure is pushing the firms into the business. "Mavericks without these moral scruples went into the business and did really well and their clients didn't get caught," adds Bankman.

But now, firms and their clients are getting caught and fined for using abusive tax shelters. Henry Camferdam blames his troubles with the IRS on the firms that sold him a $50 million tax shelter.

"Ernst and Young came to us...and said, 'Look, instead of paying all these taxes, why don't we do a tax shelter,'" says Camferdam, who was selling his business with the help of accountants Ernst and Young. "When they're a trusted advisor, you're going to listen."

The shelters are so lucrative and proprietary that Camferdam had to pay $1 million in fees and sign a strict non-disclosure agreement. He had to also pay $2 million to the law firm of Jenkins and Gilchrist for providing an "independent" legal opinion saying the shelter would work.

"You can't make $2 million a pop and be independent in any meaningful way. I would think that [Jenkins and Gilchrist] were quite interested in how many people bought that shelter," says Bankman.

Camferdam and scores of other clients bought the shelter, called the Currency Options Bring Reward Alternatives, or COBRA, but had their names turned over to the IRS by Ernst and Young when the IRS began an investigation.

"[The IRS] talked like we're the cheats...who defrauded the government," says Camferdam, who the IRS says owes it $13 million, plus interest and penalties. The IRS is auditing all the other clients who purchased the tax shelter, too.

"What I don't understand is why they have not gone after Ernst and Young, Jenkins and Gilchrist and Deutsche Bank, who designed, marketed and led us into this transaction," asks Camferdam. "That's what you use these people for. If they tell us not to do something, we don't do it. If they tell us to do something, we do it."

Ernst and Young and Jenkins and Gilchrist refused 60 Minutes' request to be interviewed on camera, but issued statements saying everything they did was completely legal. Camferdam is suing them for $1 billion, alleging they knowingly lured customers into an "illegitimate tax sham."

Paul Clikeman 
Robins School of Business 
University of Richmond Richmond, VA 23173 804-287-6575 
pclikema@richmond.edu 

Forwarded by David Albrecht on July 20, 2003

July 19, 2003
Business: S.E.C. Demands 6-Month Ban on New Ernst & Young Clients

By JONATHAN D. GLATER
Federal regulators reiterated their demand yesterday that the accounting
firm Ernst & Young be banned from accepting new audit clients for six
months as a penalty for violating conflict-of-interest rules in the 1990's.

Full Story: http://www.nytimes.com/2003/07/19/business/19AUDI.html?tntemail1 

"Whistleblower Says He Just Wanted Coke to Listen," SmartPros, September 17, 2003 --- http://www.smartpros.com/x40589.xml 

Matthew Whitley wanted to work for Coca-Cola Co. so much he submitted his resume 15 times. After being hired, the auditor and finance manager drank nothing but water and Coke and decorated a room in his house with company trinkets.

Eleven years later, Whitley is drinking only water. His wife sold the Coke plates, glasses and memorabilia at a garage sale. He is out of his $140,000-a-year job after accusing officials of the world's largest soft drink maker of shady accounting and fraudulent marketing practices.

Whitley, 37, was fired March 26, five days after sending his allegations to the company's top lawyer, although Coke said he was dismissed as part of a restructuring and not because he spoke up. Whitley demanded $44.4 million from Coke in exchange for his silence, but was refused, and is now suing the company for unspecified damages, charging Coke with wrongful termination, fraud, slander and intentional infliction of emotional distress.

"I'm the last one who wanted any of this to happen," Whitley said. "I wanted somebody to take what I was saying seriously."

In some ways, he's gotten his wish. Federal prosecutors are conducting a criminal investigation of claims in his suit, including allegations that Coke rigged a marketing test of Frozen Coke, a slush drink, at Burger King restaurants in Virginia in 2000. Coke has offered to pay Burger King $21 million as part of an apology.

A Superior Court judge earlier this month dismissed more than half of Whitley's claims, including allegations that Atlanta-based Coke sought to hide fraud, but ruled the lawsuit may continue. The suit also is filed in federal court; that case was not affected by the judge's decision.

E. Christopher Murray, an employment law expert in Garden City, N.Y., said the fact that the suit survived a motion to dismiss, even if it is a scaled-down version, is a victory for Whitley, who will now be able to depose Coke executives and obtain documents from the company. Most such cases are thrown out, he said.

Because the judge left intact Whitley's claims of intentional infliction of emotional distress and slander, he will be able to delve into the fraud allegations to show Coke had a motive for its actions, Murray said.

But legal tactics Coke is likely to use could prolong the case, he said.

"With the larger companies, what they normally do is fight you tooth and nail, file thousands of discovery motions, put you through the wringer, until they wear you out," Murray said. "I'm sure that's what Coca-Cola will do."

Coke has denied most of the charges but conceded that some employees improperly influenced the marketing test.

Continued in the article.

The reply from the Audit Committee at Coca Cola can be found at http://www2.coca-cola.com/presscenter/nr_20030617_corporate_audit_whitley_statement.html 

The auditing firm is Ernst & Young.

Bob Jensen's threads on whistle blowing are at http://www.trinity.edu/rjensen//FraudConclusion.htm#WhistleBlowing

"Large Size of Travel Rebates Adds to Questions on Ernst," by Jonathan Weil, The Wall Street Journal, November 20, 2003 --- http://online.wsj.com/article/0,,SB106928498427833800,00.html?mod=mkts_main_news_hs_h 

Ernst & Young was awarded $98.8 million of undisclosed rebates on airline tickets from 1995 through 2000, mostly on client-related travel for which the accounting firm billed clients at full fare, internal Ernst records show.

The rebates are at the crux of a civil lawsuit here in a state circuit court, in which Ernst & Young LLP, KPMG LLP and PricewaterhouseCoopers LLP are accused of fraudulently overbilling clients for travel expenses by hundreds of millions of dollars since the early 1990s. The tallies are the first precise annual airline-rebate figures to emerge in the case for any of the three accounting firms.

Ernst and the other defendants, in the lawsuit brought by closely held shopping-mall operator Warmack-Muskogee LP, have acknowledged retaining large rebates from travel companies without disclosing their existence to clients. But they deny that their conduct was fraudulent, saying they used the proceeds to offset costs they otherwise would have billed to clients through higher hourly rates. Confidentiality provisions in the firms' contracts, standard in the airline industry, barred parties from disclosing the contracts' existence or terms.

Court records show that Ernst had rebate agreements with three airlines: American Airlines' parent AMR Corp., Continental Airlines, and Delta Air Lines. The airline rebates soared to $36.7 million in 2000, compared with $21.2 million in 1999 and $5.2 million in 1995, reflecting a trend among major accounting firms to structure their volume discounts with select airlines as rebates rather than upfront price reductions.

A May 2001 chart by Ernst's travel department shows the firm estimated that its 2001 rebates would be $39.8 million to $44 million, including at least $21.2 million from AMR and $8.3 million from Continental.

Of Ernst's three "preferred carriers," two -- AMR and Continental -- are audit clients of the firm. Some investors say the large dollar figures, combined with a reference in one Ernst document to the firm's arrangements with AMR, Continental and seven other travel companies as "strategic partnering relationships," raise questions about how such payments mesh with Securities and Exchange Commission requirements that auditors be independent. The reference was contained in a 2001 presentation outlining the travel department's goals and objectives for the following year.

Audit firms generally aren't allowed to have partnership arrangements with clients in which the auditor would appear to be a client's advocate, rather than a watchdog for the public. SEC rules bar auditors from having direct business relationships with audit clients, with one exception: if the auditor is acting as "a consumer in the normal course of business."

The rules don't clearly spell out the full range of business relationships that would fall under that category. Ernst says its relationships with AMR and Continental qualified for the exception. Generally, auditors can buy goods and services from audit clients at volume discounts, if the prices are fair market and negotiations are arm's length. Ernst, American and Continental say theirs were. Ernst's terms with American and Continental were similar to those with Delta, which wasn't an audit client.

In a January 2000 e-mail to an Ernst consultant, Ernst's travel director explained that, within the airline industry, "point-of-sale discounts are the industry norm, not back-end rebates." Many large professional-services firms tended to prefer back-end rebates, however. A September 2000 presentation by Ernst's travel department said "the back-end rebate structure is consistent with practices in other large professional-services firms," including the other four major accounting firms and investment banks Credit Suisse First Boston and Morgan Stanley. It also said an outside consulting firm, Caldwell Associates, had deemed the competitiveness of Ernst's travel contracts "to be above average," compared with those of the other four major accounting firms.

In a statement, Ernst says: "There is no independence rule of any sort that would prohibit our receipt of rebates for volume travel in the normal course of business. As is the case with any large airline customer, we receive discounts on tickets purchased from American based on the volume of our business. ... It is entirely unrelated to our audit work for the airline."

Ernst & Young Sued and Fired by Drug Distributor --- http://www.accountingweb.com/item/97536

AccountingWEB US - May-7-2003 - Drug distributor Accredo Health Inc. has fired its auditor, Big Four firm Ernst & Young, and is suing the firm for more than $53.3 million.

Last year E&Y examined the financial statements of home health care service company Gentiva Health Services and provided information to Accredo that led to the acquisition of Gentiva by Accredo. After the acquisition Accredo determined that Gentiva's allowance for doubtful accounts was understated.

In the lawsuit Accredo claims that E&Y failed to properly determine reserves needed to cover Gentiva's bad debts. Accredo accuses E&Y of accounting and auditing malpractice, negligent misrepresentation, breach of contract, and violating the Tennessee Consumer Protection Act. In response, Ken Kerrigan, E&Y spokesman, said, "Ernst & Young was surprised by Accredo's action today. We believe our work fully complied with all professional standards and we will defend ourselves vigorously."

This isn't the only legal issue Ernst & Young has to contend with. The firm is currently working with a Senate panel that is investigating possible abuses regarding tax shelters sold by the firm. E&Y has also been in the news lately for its involvement in providing tax advice to Sprint executives, its questionable audit techniques with regard to the Swiss state of Geneva, and its recently dismissed charges regarding the audit of British-based Equitable Life, among other high-profile cases.

"U.C. Sues Ernst & Young Over AOL-Time Warner Actions< by the Editors of The Accounting Web on April 17, 2003 --- http://www.accountingweb.com/cgi-bin/item.cgi?id=97444&u=ee2eC47&m=4518 

AccountingWEB US - Apr-17-2003 - The University of California (UC) filed suit on April 14 against Big Four accounting firm Ernst & Young LLP and 32 other defendants, claiming it misrepresented the financial situation of America Online and Time Warner around the time of the firms’ 2001 merger.

AOL stock plummeted soon after the merger with Time-Warner and UC lost $450 million.

In the suit, the university claims that E&Y, concerned with holding on to a fat contract, helped falsify financial facts and continued to offer an unqualified audit opinion of the company long after it was clear that the company was in trouble.

An EY spokesman denied the charges. "We continue to strongly stand behind our work," E&Y spokesman Ken Kerrigan said.

Despite the lawsuit, another branch of E&Y will continue its wide-scale review of the University of California's Los Alamos National Laboratory’s financial operations. The university manages the laboratory, which is the subject of congressional charges of theft, fraud and mismanagement.

"It's like you being indicted because your brother stole something," UC spokesman Trey Davis said. "It's really quite separate."

Only a few firms are qualified to do the kind of work E&Y is doing at Los Alamos and more than 30 consultants from E&Y’s government contract services group are involved in a top-to-bottom review of the lab’s operations.

Dec. 31, 2002 (Crain's New York Business) — Ernst & Young International (E&Y) is being sued by former clients for setting up a tax shelter for them --- http://www.smartpros.com/x36550.xml 

Two E&Y Partners Suspended by SEC For Failure to Catch Fraud --- http://www.accountingweb.com/item/97512

AccountingWEB US - May-1-2003 - Two Ernst & Young partners settled a civil lawsuit filed by the Securities and Exchange Commission (SEC) by agreeing to a suspension from auditing public companies for at least four years. The suit alleged that Kenneth Wilchort and Marc Rabinowitz, who both work in E&Y’s Stamford, CT office, failed to detect accounting fraud at Cendant Corporation and its predecessor, CUC International.

In 1977 CUC International merged with HFS Inc. to form Cendant, a travel and real estate provider that is also the franchiser of Jackson Hewitt, the second-largest tax service in the United States. Mr. Wilchort served as audit engagement partner for Cendant from 1990 until 1996. He was succeeded by Mr. Rabinowitz, who held the position until 1998.

In its complaint letter, the SEC claims that between 1995 and 1998, Cendant managers devised a scheme that inflated operating income by more than $500 million. The SEC alleges that Mr. Wilchort and Mr. Rabinowitz aided and abetted these violations by approving financial statements that did not conform to generally accepted accounting principles. The SEC further alleges that the two men excessively relied on management’s representations and failed to perform independent testing even when there were "multiple, conflicting and sometimes contradictory" financial documents.

Continued in the article.

HealthSouth and Earnst & Young

Nonetheless, Mr. Smith and HealthSouth's chief executive, Richard Scrushy, on two occasions last year swore in public filings that the company's financial statements fairly presented HealthSouth's financial condition and operating results. Those quarterly certifications, which the Sarbanes-Oxley Act began requiring last year, appear to have made it much easier for prosecutors to build their case against Mr. Smith. The SEC filed civil charges against Mr. Scrushy Wednesday, but he hasn't been charged criminally. Prosecutors referred to HealthSouth's CEO and other unnamed HealthSouth senior executives as co-conspirators throughout Wednesday's court filings. Neither Mr. Scrushy nor his lawyer could be reached for comment.
Jonathon Weil  

Auditors looking into the fraud at HealthSouth have found it to be far more extensive than originally thought-as much as $4.6 billion in all. Initially, estimates put the fraud at $3.5 billion at the Birmingham, AL-based operator of rehabilitative clinics. The auditing firm implicated in the HealthSouth scandal is Ernst & Young
AccountingWeb, January 22, 2004 --- http://www.accountingweb.com/cgi-bin/item.cgi?id=98609 

To Follow:  Another Billion Dollar Lawsuit Against Ernst & Young
"Prosecutors Outline Practices Behind HealthSouth Charges,: by Jonathan Weil, The Wall Street Journal, March 20, 2003  
Page C1 --- http://online.wsj.com/article/0,,SB104813028448850400,00.html?mod=todays%5Fus%5Fmoneyfront%5Fhs

You can also read more about the HealthSouth details at http://www.trinity.edu/rjensen/fraud033103.htm#HealthSouth

The Fraud Advisory Panel in the United Kingdom --- http://www.fraudadvisorypanel.org/ 

The Panel's role is to alert the nation to the immense social and economic damage caused by fraud and help both public and private sectors to fight back. It is dedicated to a holistic approach and the long view. The Panel works to: 

• originate proposals to reform the law and public policy on fraud 
• develop proposals to enhance the investigation and prosecution of fraud 
• advise business on fraud prevention, detection and reporting 
• assist in improving fraud related education and training in business and the professions establish a more accurate picture of the extent, causes and nature of fraud

Established in 1998 through a public spirited initiative by the Institute of Chartered Accountants in England and Wales, the Panel exists to challenge complacency and supply remedies.

The Panel is an independent body of volunteers drawn from the law and accountancy, banking, insurance, commerce, regulators, the police, government departments and public agencies. It is not restricted by seeing the problem from any single point of view but works to encourage a truly multi-disciplinary perspective. The Panel is given a serious hearing as a consequence and has contributed to the new, and more vigorous attitude in government towards fraud.

August 28 message from W. O. Mills III [WOM@WOMILLS.COM] 

There actually ARE Tax Shelters out there. A tax shelter is an investment that usually requires substantial contributions with a degree of risk. It often involves current losses to produce future gains. An investment in low income property that provides depreciation benefits is one example of a legitimate tax shelter. Generally, the amount of your deductions or losses from most activities is limited to the amount that you have at risk. You are considered at risk in an activity for the following amounts:

The amount of cash you invested in the activity, The adjusted basis of other property you contributed to the activity; and The amount you borrowed to invest in the activity, to the extent that you are personally liable on the loan or have pledged property not used in the activity as security. For more information on the at risk rules, refer to Publication 925 (PDF), Passive Activity and At Risk Rules.

Note Tax shelter trade or business activity losses or credits are often considered passive activity losses or credits. Such losses or credits may only be used to offset income from other passive activities. They cannot be deducted against other income such as wages, salaries, professional fees, or portfolio income such as interest and dividends. Allowable losses or credits are computed on Form 8582 (PDF), Passive Activity Loss Limitations.

The excess passive losses and credits generated from passive activity tax shelters can be carried forward until you can use them or until you dispose of your investment in the tax shelter.

For more information on passive income and losses, refer to Tax Topic 425, or refer to Publication 925.

Abusive tax shelters exist solely to reduce taxes unrealistically. Abusive tax shelters are often marketed by promising a larger write-off than the amount invested. These schemes involve artificial transactions with little or no economic foundation. Generally, one invests money to make money. A legitimate tax shelter exists to reduce taxes fairly and also produce income. As with any investment, a real tax shelter involves risks, while an abusive tax shelter involves little risk, despite outward appearances.

A series of tax laws has been designed to halt abusive tax shelters. These include requiring sellers of tax shelters to register them using Form 8264 (PDF), Application for Registration of a Tax Shelter, requiring sellers to maintain a list of investors, and requiring investors to report the tax shelter registration number on their tax return using Form 8271 (PDF), Investor Reporting of Tax Shelter Registration Number.

Investors in abusive tax shelters whose returns are examined may be required to pay more tax, plus penalties and interest. Also, promoters of abusive tax shelters may be liable for significant penalties.

There are several legitimate investments you can make that will defer income until a later date, such as Individual Retirement Arrangements, retirement plans for self employed individuals, and deferred annuities. These are not considered tax shelters because they usually do not involve tax losses. For more information concerning tax shelters, including issues to consider before investing, refer to Publication 550 (PDF), Investment Income and Expenses.

...hopefully your client is NOT looking for an ABUSIVE one...

W. O. Mills III Dallas, Texas www.womills.com 

Vivendi is audited by Ernst & Young International

"Officials face probe for Vivendi share moves," by Jo Johnson, The New York Times, March 30, 2004

French prosecutors yesterday put the head of Deutsche Bank's equities business in France and two senior officials in Vivendi Universal's finance department under formal investigation for alleged share-price manipulation at the French media group.

These are the first formal investigations since prosecutors opened their probe into Vivendi Universal in October 2002, four months after the resignation of Jean-Marie Messier as chief executive.

. . . 

The developments in France come three months after the media group agreed to pay $50m (£28m) to the Securities and Exchange Commission last year to settle fraud claims.

Coke:  Gone Flat at the Bright Lines of Accounting Rules and Marketing Ethics
The king of carbonated beverages is still a moneymaker, but its growth has stalled and the stock has been backsliding since the late '90s.  Now it turns out that the company's glory days were as much a matter of accounting maneuvers as of marketing magic. 
Guizuenta's most ingenious contribution to Coke, the ingredient that added rocket fuel to the stock price, was a bit of creative though perfectly legal balance-sheet rejeiggering that in some ways prefigured the Enron Corp. machinations.  Known inside the company as the "49% solution," it was the brain child of then-Chief Financial Officer M. Douglas Ivester.  It worked like this:  Coke spun off its U.S. bottling operations in late 1986 into a new company known as Coca-Cola Enterprises Inc., retaining a 49% state for itself.  That was enough to exert de facto control but a hair below the 50% threshold that requires companies to consolidate results of subsidiaries in their financials.  At a stroke, Coke erased $2.4 billion of debt from its balance sheet.
Dean Foust, "Gone Flat," Business Week, December 20, 2004, Page 77.  
This is a Business Week cover story.
Coca Cola's outside independent auditor is Ernst & Young

There were other problems, some of which did not do the famed Warren Buffet's reputation any good.  See "Fizzy Math and Fishy Marketing Lawsuit, Probes Prove Damaging to Coke," by Margaret Webb Pressler, Washington Post, June 20, 2003 --- http://www.washingtonpost.com/ac2/wp-dyn?pagename=article&contentId=A14384-2003Jun19&notFound=true 

Coca Cola's marketing tactics were unethical and unhealthy for kids --- http://www.econ.iastate.edu/classes/econ362/hallam/Coke%20Officials%20Beefed%20Up.pdf 

Also see "The Ten Habits of Highly Defective Corporations," From The Nation --- http://www.greenmac.com/World_Events/thetenha.html 

It Just Gets Deeper and Deeper for KPMG

Bob Jensen's Most Difficult Message (written December 4, 2001) --- http://www.trinity.edu/rjensen/fraud.htm#Blame 
The theme is how large CPA firms wear two faces like the theatrical symbol.
Bob Jensen's Commentary on the Above Message From the CEO of Andersen
     (The Most Difficult Message That I Have Perhaps Ever Written!)
     This is followed by replies from other accounting educators.

The Two Faces of Large Public Accounting Firms

When the Enron/Anderson scandals were just commencing to unfold, I wrote "The Most Difficult Message That I have Ever Written" at  http://www.trinity.edu/rjensen/fraud.htm#Blame 
Note that you have to read the preliminaries and then scroll down to my message.

Year 2003 Update on the Same Theme of Two Faces of Public Accounting Firms

KPMG's  Smiling Face

KPMG provides a sad illustration of the two faces.  KPMG has done wonderful things in support of accounting education and accounting research.  They have helped to fund faculty, and even helped to fund my salary when I was a KPMG Professor of Accounting at Florida State University.  The KPMG Foundation has taken on a huge commitment to raise funds for supporting minority students in doctoral programs.  Some of KPMG's most wonderful programs are described at http://www.kpmgfoundation.org/ 

A recent example of KPMG's initiative to help reduce fraud.
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.

"KPMG Honored for Programs in Support of Disabled," SmartPros, November 22, 2005 --- http://accounting.smartpros.com/x50745.xml

Accounting firm KPMG has been selected by the YAI/National Institute for People with Disabilities (NIPD) Network as its "2005 Corporation of the Year" recipient.

The annual award was accepted by KPMG LLP chairman and CEO Timothy P. Flynn at the agency's "Share the Joy" gala in Manhattan this month. The YAI/NIPD Network is a network of not-for-profit health and human services agencies for people with developmental and learning disabilities.

"This award recognizes KPMG for their long and continued commitment to helping create jobs for people with disabilities, and also their support of YAI's fundraising activities," said Dr. Joel M. Levy, CEO of the YAI/NIPD Network. "We are thankful for their continued support, and we are pleased to recognize KPMG as a firm that is dedicated to making a difference in the lives of these individuals."

KPMG's Flynn commented, "KPMG has supported the YAI/NIPD Network and its programs through volunteerism, board participation and individual and corporate fundraising initiatives for more than a decade. We are honored to be chosen for this distinguished award and pleased to be among an impressive list of past and present honorees."

Past honorees of the award have included Pfizer, Avon Products, RJR Nabisco and Time.

"KPMG Opens Its Books (a Bit), Offering Glimpse of U.S. Results," by Jonathan Weil, The Wall Street Journal, January 26, 2005, Page C4 --- http://online.wsj.com/article/0,,SB110669725882735997,00.html?mod=todays_us_money_and_investing 

In a break from other large U.S. accounting firms, KPMG LLP offered a peek at its financial results for its most recently completed fiscal year, though it stopped well short of disclosing a complete set of financial statements.

KPMG, the fourth-largest U.S. accounting firm, said it had $4.1 billion in revenue for the year ended Sept. 30, up 8% from a year earlier. The New York-based firm, which is the U.S. affiliate of KPMG International, also reported a 4% decline in profits available for distribution to partners, though it declined to disclose what its fiscal 2004 profits were. Globally, KPMG International said its world-wide affiliates had $13.44 billion of combined revenue for fiscal 2004, up 15% from a year earlier.

Among the factors that weighed on the U.S. firm's earnings were higher litigation costs, including settlements, insurance costs and legal fees. In a statement, Eugene O'Kelly, KPMG LLP's chairman and chief executive, said such costs "as a percentage of revenue across the U.S. accounting profession are running in the double digits, second only to compensation costs, a level that is unsustainable for our profession in the long run."

KPMG, like the other major accounting firms, faces a host of potentially costly lawsuits over its audit work for companies that have disclosed accounting irregularities. Additionally, the U.S. firm's sales of allegedly abusive tax shelters remain the focus of a criminal investigation by a federal grand jury in New York. The firm says it is cooperating with investigators. Last week, KPMG announced that U.S. District Judge Sven Erik Holmes of Tulsa, Okla., 53 years old, will join the firm as its vice chairman of legal affairs, a new position from which he will direct the firm's office of general counsel.

KPMG's decision to disclose its U.S. revenue -- and offer even a directional indication about U.S. profit -- represents a departure from the recent practice at other major accounting firms. Unlike corporations with parent-subsidiary structures, the Big Four accounting firms are structured as loose alliances of independent partnerships that belong to so-called global membership organizations. Generally, their practice has been to announce member firms' combined global revenue, broken down by continent.

"KPMG gains from stricter rules and law changes," by Leon Gettler, Sydney Morning Herald,  January 27 2005 --- http://www.smh.com.au/text/articles/2005/01/26/1106415664712.html 

Tougher rules in Australia and overseas and fatter audit fees have helped push KPMG's global revenue up 14.7 per cent to $US13.44 billion ($17.58 billion) for the year to September 30.

The result shows that the demise of global rival Andersen and the advent of tougher regulations forcing accounting firms to focus on quality audit work have not hampered their growth. Under the new conflict of interest rules, accountants are also picking up non-audit work, such as advisory services and tax, from their competitors' audit clients.

In Australia, KPMG's revenue rose 10.2 per cent to $606 million in the year to June 30, 2004.

More than half came from the Australian firm's audit and risk advisory service, which generated revenue of $346 million, up 10.5 per cent, as corporations called in experts on the international financial reporting standards and the United States' Sarbanes-Oxley Act.

Demand was also driven by Australian companies adjusting to new regulations under the Corporate Law Economic Reform Package (CLERP 9), which includes requirements for chief executives and chief financial officers of listed companies to make declarations that financial reports are in line with accounting standards and are true and fair.

The fatter revenue also reflects increased audit fees. These have been rising as all the big firms, except Deloitte, have sold off their consulting practices to avoid being tainted with accusations of conflicts of interest.

KPMG Australia's chief executive officer, Lindsay Maxsted, said the increased revenue came from a mix of bigger fees and higher demand from risk-averse company boards.

A survey by High Fliers Research of more than 7,000 graduating university students has ranked audit, tax and advisory firm KPMG as the top graduate employer out of 500 organisations.  
Double Entries, December 2, 2004 ---  http://accountingeducation.com/news/news5680.html  

Duke and Pace researchers shed light on corporate tax shelters
A study by researchers from Duke University and Pace University found that use of corporate tax shelters not only allows organizations to avoid billions of dollars in annual tax payments, it may also help companies artificially enhance their attractiveness to investors by reducing levels of debt. The study also explores some commonly used tax shelters and the characteristics of firms that have employed these shelters. Finance professors John R. Graham of Duke's Fuqua School of Business and Alan L. Tucker of Pace's Lubin School of Business collected the largest known sample of tax shelters utilized by corporations during the past 25 years.
"Duke and Pace researchers shed light on corporate tax shelters," Lubin, December 22, 2004 --- http://snipurl.com/DukePace

"KPMG Creates Ethics Global Center," SmartPros, July 14, 2004 --- http://www.smartpros.com/x44314.xml 

KPMG International announced the launch of the Global Center for Leadership & Business Ethics, designed to recognize those individuals who exhibit extraordinary business ethics and leadership qualities.

The establishment of the Global Center follows the announcement that KPMG International had been named the Global Founding Partner of the Nobel Peace Center in Oslo, Norway.

"As a demonstration of our fundamental commitment to the principles of leadership, integrity and ethics, KPMG is serving as a catalyst to establish an independent entity, the Global Center, that will recognize those business leaders who reflect the attributes of accomplishment and innovation," said Gene O'Kelly, chairman and chief executive of KPMG LLP, the U.S. member firm.

O'Kelly said that the separate role of Global Founding Partner of the Nobel Peace Center -- in combination with the creation of the independently operated Global Center -- as well as the Laureate & Award Medal Series comprises the "Global Initiative on Leadership & Business Ethics."

The Global Center will manage and administer the nomination process for the Laureate Award & Medal Series, which will honor those who are committed to excellence in business ethics. The processes, governance and nomination of the Laureate Award and Medal Series are modeled on Nobel.

The Laureate Award will honor a leader who best exemplifies business ethics and who has shown his or her commitment to excellence. In addition to the Laureate Award, medals will be awarded for Leadership, Corporate Governance, Reporting & Disclosure, Social Responsibility and Education.

A chairman for the Global Center will be appointed shortly, and a call for nominations for the Laureate Award & Medal Series will follow. Winners will be determined in November and the awards will be presented in December the same week that Nobel prizes are given.

"One of our highest priorities at KPMG is leading the restoration of credibility to the accounting profession," said Timothy R. Pearson, vice chair, marketing and communications, KPMG LLP. "The Global Initiative is inspired by the spirit of the Nobel Prizes and the principles and guidelines of the Nobel Foundation and the Norwegian Nobel Committee, and is aimed at recognizing outstanding business leaders."

Figure This

Treasury taps KPMG as auditors in controversial decision while at the same time the Justice Department has a criminal investigation of KPMG for selling nearly $2 billion in illegal tax shelters.  Will KMPG employees have to be paroled to conduct the Treasury audit?

"Treasury Taps KPMG as Auditors in Controversial Decision," The AccounitngWeb, July 20, 2004 --- http://www.accountingweb.com/cgi-bin/item.cgi?id=99502 

The Treasury Department is simultaneously investigating KPMG’s tax shelter practice while hiring the firm to audit its own consolidated financial statements.

Senate Finance Committee Chairman Charles E. Grassley, R-Iowa, was angered at the news, according to the Washington Post. He said Treasury is undercutting its own tax probe by awarding KPMG the contract to examine the books of Treasury’s 12 bureaus, which account for $6.9 trillion in assets and would be KPMG’s biggest audit ever.

"What signal does it send when the government is hauling one of the big accounting firms into the grand jury room over tax fraud while handing that same company millions of dollars in taxpayer-funded contracts?" Grassley asked.

Treasury Department spokesman Robert S. Nichols said the agency's independent inspector general picked KPMG. With 70 percent of the inspector general’s resources moved to the Department of Homeland Security, the office decided to seek private bids for the work.

"On the issue of tax shelters, let me affirm that the Bush administration has taken aggressive action to address the abusive tax shelter problem, more so than in any period in recent memory," he said.

KPMG said that it would not be auditing the books of the IRS, which has repeatedly demanded that the firm release the names of clients who use its tax shelters. The General Accounting Office, by statute, must conduct the IRS audit. Also, KPMG spokesman George Ledwith said that none of the firm’s employees involved in the federal investigation will be working on the Treasury audit.

The Senate Finance Committee pointed to the KPMG contract as one example of federal agencies overlooking tax abuses. The committee claims the Transportation Department has encouraged abusive leasing arrangements, the Patent and Trademark Office has issued patents for tax shelters and the Interior Department has engaged in inflating land swaps. The committee has set hearings for Wednesday on federal efforts to collect taxes owed.

"If we could just get federal agencies not to work at cross purposes, it would go a long way toward ensuring everybody pays their fair share of taxes," Grassley said. "The IRS's job would be a lot easier if other government agencies were part of the solution, not part of the problem."

This fits perfectly into Bob Jensen's earlier theme of The Two Faces of KPMG (see below)

KPMG's Sad Face 

Integrity is a cornerstone of our culture and we continue to make great progress in our effort to build a model ethics and compliance program. This means fostering awareness, trust, and personal responsibility at every level of the firm. This year, we issued our first ever ethics and compliance progress report and guidebook. This report, Ethics and Compliance Report 2007: It Starts with You, highlights initiatives that we have in place to support our values-based compliance culture, and features real-life stories of some of KPMG's partners and employees who faced ethical challenges and how they handled them. We responded to heightened interest in ethics education and input from your fellow academics and created our KPMG Ethical Compass—A Toolkit for Integrity in Business, a three-module package of classroom materialsto help you present ethics-related topics to your students.
An Open Letter From Tim Flynn, Chairman and CEO, KPMG LLP
This was part of an email message that I assume was sent to the academy of accountants.

Once again the link to the Ethics and Compliance Report 2007 is at http://www.kpmgcampus.com/whoweare/ethics.pdf

The settlements announced today, including the largest penalties ever imposed on individual auditors, reflect the seriousness with which the SEC regards the responsibilities of gatekeepers."

It took forever, but KPMG partners finally settle with the SEC on the really old Xerox accounting fraud
The Commission (SEC) has announced on February 22, 2006 that all four remaining defendants in an action brought against them and KPMG LLP by the agency in connection with a $1.2 billion fraudulent earnings manipulation scheme by the Xerox Corporation from 1997 through 2000 have agreed to settle the charges against them. Three partners agreed to permanent injunctions, payment of record civil penalties and suspensions from practice before the Commission with rights to reapply in from one to three years. The fourth partner agreed to be censured by the Commission. "This case represents the SEC's willingness to litigate important accounting fraud allegations against major accounting firms and their audit partners, even where the accounting was complex," said Linda Chatman Thomsen, the SEC's Director of Enforcement. "The settlements announced today, including the largest penalties ever imposed on individual auditors, reflect the seriousness with which the SEC regards the responsibilities of gatekeepers."
Andrew Priest, "FOUR CURRENT OR FORMER KPMG PARTNERS SETTLE SEC LITIGATION RELATING TO XEROX AUDITS," Accounting Education News, February 23, 2006 ---
http://accountingeducation.com/index.cfm?page=newsdetails&id=142393

Big 4 Securities Class Action Litigation- Citing Auditor as Defendants --- http://www.trinity.edu/rjensen/AuditingFirmLitigationNov2006.pdf

KPMG Going to Court in New Jersey for Alleged  professional malpractice and negligence

"KPMG Ordered to Stand Trial in Fraud Law," SmartPros, July 28, 2008 --- http://accounting.smartpros.com/x62665.xml

Big Four auditing firm KPMG LLP has been ordered by a New Jersey Superior Court judge to stand trial in an accounting fraud lawsuit involving Cast Art Industries, according to a statement issued Friday by law firm Eagan O'Malley & Avenatti, which represents Cast Art.

Cast Art sued KPMG in 2003 for professional malpractice and negligence for allegedly failing to detect a pervasive financial fraud at Papel Giftware, Inc. prior to Cast Art acquiring Papel in December 2000 for nearly $50 million.

In a written opinion, Judge Heidi Willis Currier found sufficient evidence for a jury trial to proceed against KPMG, Papel's auditor.

In one email uncovered during the lawsuit, a member of Papel's management described how the company had "raped and pillaged to an extreme" in order to meet its forecasts. A KPMG partner later acknowledged, in a memorandum he sent to others at KPMG, that Papel's management could not be trusted.

The lawsuit alleges that KPMG knew Papel's management could not be trusted yet repeatedly represented to Cast Art and others that Papel's financial statements were accurate and no fraud had occurred.

"Wall Street, Main Street, investors, and the public at large depend on auditing firms to be truthful and accurate when reporting on the financial condition of company," stated Michael Avenatti, a lawyer for Cast Art. "In this case, like in too many others, KPMG cut every possible corner and fell woefully short."

Cast Art claims that for three years prior to its acquisition of Papel, KPMG repeatedly affirmed that Papel's financial statements were accurate when in reality the company's management had engaged in a number of fraudulent schemes designed to inflate the value of the company to potential buyers. Cast Art alleges that Papel's management booked tens of thousands of fraudulent transactions on the company's books and records by, among other things, purposely shipping product to phony customers and double and triple shipping the same product to the same customer.

Cast Art plans to seek close to $50 million at trial. Opening statements are expected to begin in the trial on Sept. 15, 2008.

One Case in Which KPMG is Not in Favor of Transparency

"KPMG Aims to Cloak Details of Client's Case:  Auditor's Settlement Offer Would Muzzle Targus Group Regarding Sanctions Order," by David Reilly, The Wall Street Journal, March 20, 2006; Page C3 --- Click Here

In trying to settle a lawsuit brought against it by a former client, KPMG LLP has proposed terms aimed at preventing other clients from learning the auditor was sanctioned by a judge in the matter.

KPMG has offered to settle for $22.5 million a suit filed against it by Targus Group International Inc., a California computer-case maker, according to a draft settlement proposal reviewed by The Wall Street Journal. Targus claimed the accounting giant was negligent in failing to detect alleged embezzlement by a former executive at the company. KPMG has disputed that claim.

The proposed settlement payout is small compared with the $465 million KPMG agreed to pay last year as part of a deferred-prosecution agreement reached with the Justice Department. That agreement, which helped the firm avoid a potentially catastrophic criminal indictment, related to KPMG's sale of questionable tax shelters.

But the nonmonetary settlement terms being proposed by KPMG to Targus underscore how big accounting firms are pursuing every means at their disposal to limit their litigation liability and curtail the ability of clients to bring cases against them. Other measures taken include terms that some auditors are writing into their engagement contracts that would limit the clients' ability to pursue legal action against them.

In the proposed settlement with Targus, KPMG wants details of the case sealed and wants Targus to ask the state judge who sanctioned KPMG to vacate, or overturn, that order, according to the settlement document. The order, filed last July, sanctioned KPMG for obstruction during pretrial proceedings, known as discovery, and fined it $30,000. The judge also instructed any jury hearing the case against KPMG to take into account the firm's failure to produce "requested documents in a full and timely manner." At the time, KPMG said that it complied with the judge's discovery orders and appealed the ruling. That appeal is pending in the California Court of Appeal.

Continued in article

"KPMG Settles Targus Audit Case," by David Reilly, The Wall Street Journal, March 29, 2006; Page C4 ---
http://online.wsj.com/article/SB114359862516210767.html?mod=todays_us_money_and_investing

KPMG LLP agreed to pay a former audit client $22.5 million as part of a legal settlement that also calls for a California judge to set aside a sanctions order imposed on the accounting giant last July, according to a person familiar with the matter and documents related to the case.

The settlement terms will allow KPMG to clear the legal record of a disciplinary action that could potentially be used against it by other parties who might sue the firm in the future. Orange County Superior Court Judge Geoffrey T. Glass sanctioned KPMG last summer for obstruction during pretrial proceedings.

The order emanated from proceedings related to a lawsuit brought against KPMG by former client Targus Group International Inc. The California-based computer-case maker sued the firm for malpractice, alleging KPMG's audit failed to spot alleged embezzlement by a former executive that cost the company as much as $50 million.

In settling the case, KPMG had proposed that Targus agree not to oppose a request for Judge Glass to vacate the sanctions order, according to a draft settlement proposal reviewed by The Wall Street Journal. The accounting firm also wanted records related to the case, as well as the sanctions order and its own appeal of that order, sealed, while precluding executives at Targus, or their attorneys, from speaking about or referring to the matter, according to the draft settlement proposal.

In a statement released yesterday, KPMG said: "The parties have reached a settlement. We cannot discuss the terms, which are confidential. We have settled the case to avoid more costly litigation." An attorney for Targus didn't return a call seeking comment. The company's general counsel, Michael Ward, was traveling outside the country and was unavailable for comment.

Continued in article

Also see "KPMG Case Takes Surprise Turn With Guilty Plea," AccountingWeb, March 29, 2006 --- http://www.accountingweb.com/cgi-bin/item.cgi?id=101964

"Big Four accounting firm KPMG LLP faces a class action lawsuit against its Canadian division," SmartPros, September 10, 2007 --- http://accounting.smartpros.com/x59025.xml

The lawsuit, filed this week in Ontario Superior Court, claims overtime compensation for non-chartered accountant KPMG employees who worked more than 44 hours in a week, were not paid overtime pay, and are not exempt under applicable regulation.

Chartered accountants, who make up the bulk of KPMG's staff, are excluded from overtime provisions.

The lead plaintiff, Toronto resident Alison Corless, was employed by KPMG as a "technician" between 2000 and 2004 and is seeking $87,000 in overtime pay for that period. The lawsuit filed this week seeks $20 million for the class.

This is the second unpaid-overtime class action lawsuit against a major company in Canada, following a lawsuit against Canadian Imperial Bank of Commerce.

KPMG Hit Once Again for Negligence

"The UK's economic elites cannot effectively regulate themselves: The disciplining of major accounting firms is still little more than a cynical public relations exercise," by Prim Sikka, The Guardian, July 4, 2008 --- http://www.guardian.co.uk/commentisfree/2008/jul/04/economy

Governments talk of heavy fines and incarceration for antisocial behaviour for normal people, but it is entirely different for economic elites, as exemplified by major accountancy firms. Despite recurring audit failures, they get their own courts, puny fines and little or no public accountability. Appeals professionalism and private disciplinary arrangements disarm journalists and critics and mask the usual predatory moneymaking business.

Last week, seven years after the collapse of Independent Insurance Group, the UK accountancy profession frightened KPMG with a fine of £495,000 over its audit failures. The partner in charge of the audits was fined £5,000 and the firm had to pay disciplinary hearings costs of £1.15m. The audit failures played a part in helping the company to report a loss of £105m into a profit of £22m. In October 2007, two Independent directors were jailed for seven years.

The puny fines will hardly worry KPMG or its partners. The firm boasts worldwide income of nearly $20bn (£10bn) and about £1.6bn of this is from its UK operations. Its partners are charged out at an hourly rate of £600. Last year, its 559 UK partners enjoyed profits of £806,000 each and also shared a Christmas bonus of £100m.

The seven-year delay is not unusual. The professional structures took eight years to levy a fine on Coopers & Lybrand (now part of PricewaterhouseCoopers) for audit shortcomings that might have prevented the late Robert Maxwell from looting his companies and employee's pension funds. The frauds came to light after his suicide in 1991. A UK government investigation did not report until 2001. In 1999, a professional disciplinary hearing placed most of the blame for audit failures on an audit partner who died in the intervening years. The firm was fined £1.2m for its audit failures and ordered to pay costs of £2.2m. Taken together this amounted to £6,000 per partner. Coopers had collected over £25m in fees from Maxwell. In 1999, PricewaterhouseCoopers had UK income of £1.8bn.

The fraud-ridden Bank of Credit and Commerce International (BCCI) was closed down in July 1991. Nearly 1.4 million depositors lost some part of their $8bn savings, though some UK savers were bailed out by the taxpayer funded depositor protection scheme. The UK government failed to appoint an independent inquiry to investigate the role of auditors, but a US Senate report published in 1992, raised numerous questions about the conduct of auditors. Eventually, in 2006, without commenting on any of the findings of the US Senate, a disciplinary panel of the UK accountancy profession found some faults with the audits conducted by the UK arm of Price Waterhouse (now part of PricewaterhouseCoopers). The firm was fined £150,000 and ordered to pay hearing costs of £825,000. At that time the firm had UK income of around £2bn.

The above is a small sample of what passes for self-regulation in the UK accountancy profession. The sinking ship of self-regulation has now been refloated, albeit with a few deckchairs rearranged. The government has delegated the investigation of major audit failures to the Financial Reporting council (FRC), a statutory regulator dominated by corporate and accounting elites. In August 2005, it announced an investigation into the audits of MG Rover conducted by Deloitte & Touche. So far no report has materialised.

The usual excuse is that the accountancy regulators can't do anything until all litigation is resolved. Such an excuse did not stop the US government from investigating auditors of Enron or WorldCom. There is hardly any evidence to show that the UK fines are effective or have resulted in any improvement in audit quality. Despite recurring failures, no partner from any major UK auditing firm has ever been banned from practising and no major firm has ever been suspended from selling audits. Most stakeholder lawsuits against auditors are barred after six years, and the much-delayed disciplinary findings are of little use to them. In any case, generally auditors only owe a "duty of care" to the company as a legal person and not to any individual shareholder, creditor or other stakeholder who may have suffered loss as a result of auditor negligence.

The above cases do not suggest that auditors directly participated in any of the irregular activities. Nevertheless, the disciplining of major accounting firms remains a cynical public impression management exercise. The victims of poor audits can submit evidence to disciplinary panels, but cannot appeal against its findings, or feather-duster fines. In contrast, the firms and their partners can. There is no way of knowing how any evidence gathered by the disciplinary panels is weighted or filtered. None of it is available for public scrutiny. The fines levied swell the coffers of the regulators and their sponsors and are not used to compensate the victims of audit failures. Neither the professional bodies nor any disciplinary structure owes a "duty of care" to any individual affected by their policies. It is time the economic elites were subjected to the legal processes that apply to normal people.

$2.2 Billion Alleged Accounting Fraud by Founder of Computer Associates
A special committee of the board of directors has accused Charles Wang, founder and former chairman of Computer Associates International Inc., of directing and participating in fraudulent accounting during the 1980s and 1990s. The committee's report, filed late Friday afternoon in Chancery Court in Delaware, is the first investigation that publicly ties Mr. Wang to what the government has described as a $2.2 billion accounting fraud. The committee recommended that the Islandia, N.Y., software company, which has changed its name to CA Inc., file suit to recover at least $500 million from Mr. Wang in costs related to his conduct, including a $225 million payment CA made to a government-ordered restitution fund . . . In a strongly worded statement, Mr. Wang said he is "appalled" by the "fallacious" committee report, saying it is based on the statements of "those who perpetrated the crimes at issue and then lied about them." Mr. Wang said he felt "personally wronged" by Mr. Kumar -- his successor and onetime protégé -- and called his own decision in 1994 to recommend him for the position that would eventually take him to the corner office a "major mistake."
William Bulkeley and Charles Forelle, "Directors' Probe Ties CA Founder To Massive Fraud Report Suggests Suing Wang for $500 Million; Evidence of Backdating, The Wall Street Journal, April 14, 2007; Page A1 --- http://online.wsj.com/article/SB117649886174069499.html?mod=todays_us_page_one

"Former Computer Associates CEO to Pay Over $52 Million," by Tom Hays, SmartPros, April 16, 2007 --- http://accounting.smartpros.com/x57280.xml

A judge has signed off on a restitution agreement requiring the former chief executive of Computer Associates International Inc. to pay at least $52 million - including proceeds from the sale of his yacht and pair of Ferraris - to victims of a huge accounting fraud at one of the world's largest software companies.

U.S. District Judge Leo Glasser approved the deal on Friday following a brief hearing in Brooklyn at which a special master overseeing a restitution fund announced that tens of thousands of people who lost money on the company would recover only a small fraction of their investments.

The agreement with Sanjay Kumar, who was sentenced to 12 years in prison in November for his role in the scandal, would theoretically make him liable for as much as $798.6 million in payments to investors.

Prosecutors acknowledge, though, that Kumar and his family will probably never have enough money to pay that amount.

The deal, which was filed earlier this month, calls for Kumar to instead make installment payments of $40 million, $10 million and $2 million by December of 2008, then pay 20 percent of his annual income once he is released from prison.

Those payments would continue for the rest of his life.

Kumar, 45, will be forced to sell off his stock portfolio, a 57-foot yacht in Naples, Fla., and four cars, including the Ferraris. But his family will keep its estate in Upper Brookville, on Long Island.

The agreement "allows his family to live reasonably well," said Kumar's attorney, Lawrence McMichael. "That's fair. They didn't commit a crime."

Kumar, who attended the hearing, left court without speaking to reporters. He must report to prison on Aug. 14.

The $52 million will go into a restitution fund that currently totals about $235 million, said the special master, Kenneth Feinberg. The roughly 95,000 investors who are eligible for restitution will recover only about 2.3 percent of their loss, he said.

The judge acknowledged that many investors would be disappointed with the payouts. "But that's the nature of the beast," he said.

Continued in article

The independent auditor of Computer Associates is KPMG.

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

Update on the ConAgra Case
Some questions were raised at a subsequent date about independence between KPMG and head of ConAgra's Audit Committee who is a former CEO of KPMG --- http://www.secinfo.com/drFan.z2d.d.htm

ConAgra Allegedly Cooks the Books
The Securities and Exchange Commission filed a civil complaint accusing three former ConAgra Foods Inc. executives of improper accounting practices that helped pump up profit statements. The SEC named former Chief Financial Officer James P. O'Donnell, former Controller Jay D. Bolding and Debra L. Keith, a former vice president of taxes, as defendants in the complaint filed in U.S. District Court. The complaint alleged improper accounting from fiscal 1999 through 2001. The SEC filed a separate complaint against former controller Kenneth W. DiFonzo, 55, of Newport Beach, Calif.
"ConAgra's Books Draw SEC Action," The Wall Street Journal, July 2, 2007; Page A10 --- Click Here

The Securities and Exchange Commission has filed civil charges against ConAgra Foods, Inc., alleging that it engaged in improper, and in certain instances fraudulent, accounting practices during its fiscal years 1999 through 2001, including the misuse of corporate reserves to manipulate reported earnings in fiscal year 1999 and a scheme at its former subsidiary, United Agri-Products (UAP), in 2000 that involved, among other things, improper and premature revenue recognition. ConAgra is a diversified international food company headquartered in Omaha, Neb. Linda Thomsen, Director of the Commission's Division of Enforcement, said, "This case again illustrates that the Commission will take strong action when a company and its officers engage in accounting fraud that distorts the company's true financial condition. The facts here are particularly troubling because of the number of different improprieties engaged in by Con Agra, the length of time over which they occurred, and the fact that senior management was involved in the misconduct."
AccountingEducation.com, August 9, 2007 --- http://accountingeducation.com/index.cfm?page=newsdetails&id=145322

You can read more about KPMG at http://www.trinity.edu/rjensen/Fraud001.htm#KPMG

Executive Compensation Fraud at Apple Corporation:
Apple's mea culpa on backdating last week was eloquently incomplete
Apple's mea culpa on backdating last week was eloquently incomplete, and all the more intriguing because the gaps seemed almost Socratically mapped to invite the media to fill the holes by asking obvious questions. The big joke here is that the logic of the witch hunt will stop the media from asking the obvious questions, not least because CEO Steve Jobs is a hero to much of the press and there's little appetite for bringing him down. Don't misunderstand. We believe it would be a gross injustice if he were defenestrated over backdating, just as we have serious doubts about the prosecutions launched against other backdating CEOS. And Apple's likely purpose in issuing its statement, naturally, was not lexical comprehensiveness but saving Mr. Jobs's job.
Holman W. Jenkins, Jr., "A Typical Backdating Miscreant, The Wall Street Journal, October 11, 2006; Page A15 --- http://online.wsj.com/article/SB116052823194588801.html?mod=opinion&ojcontent=otep

"Apple C.E.O. Apologizes for Stock Practices," The New York Times, October 5, 2006 --- Click Here

Now that an internal investigation over Apple Computer Inc.'s stock-option practices has helped abate investor worries over Steve Jobs' role as CEO, a key lingering concern will be the impact of pending earnings restatements.

Apple said Wednesday its three-month investigation did not uncover any misconduct of any current employees but did raise ''serious concerns'' over the accounting actions of two unnamed former officers.

The iPod and Macintosh maker also said its former chief financial officer, Fred Anderson, had resigned from the company's board of directors.

Jobs -- his position intact -- apologized.

The probe found that Jobs knew that some option grants had been given favorable dates in ''a few instances,'' but he did not benefit from them and was not aware of the accounting implications, the company said.

''I apologize to Apple's shareholders and employees for these problems, which happened on my watch,'' Jobs said in a statement. ''We will now work to resolve the remaining issues as quickly as possible and to put the proper remedial measures in place to ensure that this never happens again.''

Apple said it will likely have to restate some earnings due to revised tax and stock option-related charges. Auditors are still reviewing the situation, and Apple said it has not yet determined the extent of the financial impact.

The looming restatements could dramatically reduce some of the windfall generated during the company's recent run of record profit, analysts said.

Shares of Apple shed 10 cents to $75.28 in midday trading Thursday on the Nasdaq Stock Market. The stock has traded between $47.87 and $86.40 over the past year.

Apple has reported profit totaling $3.1 billion during the past four years. If the restatements are severe, it could dent Apple's stock, said IDC analyst Richard Shim.

''The restatements have the potential to bite them again depending on how large they end up being,'' Shim said. ''That said, the company is certainly firing on all cylinders so investors may be willing to forgive them, but it's something that will linger in the backs of their minds.''

Piper Jaffray analyst Gene Munster said he and other investors are breathing a sigh of relief that Jobs kept his job throughout the scandal.

''The risk was that if something bizarre happened and Steve Jobs got fired over it,'' Munster said from his office in Minneapolis. ''That could have significantly impacted the company in a negative way. Steve Jobs is Apple. Ultimately, the scope of the backdating was bigger than we thought, but the impact turned out to be less severe.''

Apple is one of the most prominent among more than 100 companies caught in the nationwide stock options mishandling scandal. Cupertino-based Apple initiated its own stock-options investigation in June after problems at other companies began to unravel.

In many instances, the problem has centered on the ''backdating'' of stock options -- a practice in which insiders could make the rewards more lucrative by retroactively pinning the option's exercise price to a low point in the stock's value.

Apple said its probe found irregularities in the recording of stock option grants made on 15 dates between 1997 and 2002, with the last one involving a January 2002 grant, the company said. The grants had dates that preceded the approval of those grants.

Apple spokesman Steve Dowling said the 15 grants represented 6 percent of the total issued during that period. He said he did not have further details regarding the specific grants or whether they were awarded to officers or employees.

The company did not identify the two former officers whose accounting, recording and reporting of option grants raised ''serious concerns'' during the probe.

Apple said Anderson, who served as the company's chief financial officer from 1996 until 2004, resigned from the board, citing he did so in ''Apple's best interest.''

Dowling said the company will provide more details about the probe to the Securities and Exchange Commission.

The company's special committee conducting the investigation examined more than 650,000 e-mails and documents, and interviewed more than 40 current and former employees, directors and advisers.

"Apple Says Jobs Knew of Options," by Laurie J. Flynn, The New York Times, October 5, 2006 --- Click Here

The SEC is not yet done with Apple: Where were the KPMG auditors?

"Apple's Former CFO Settles Options Case:  Finance Official Ties CEO Jobs To Stock Backdating Plan," by Carrie Johnson, The Washington Post, April 25, 2007; Page D01 --- Click Here

A former chief financial officer of Apple reached a settlement with the Securities and Exchange Commission yesterday over the backdating of stock options and said company founder Steve Jobs had reassured him that the questionable options had been approved by the company board.

Fred D. Anderson, who left Apple last year after a board investigation implicated him in improper backdating, agreed yesterday to pay $3.5 million to settle civil charges.

Chief executive Steve Jobs has not been charged in the probe. (Alastair Grant - AP)

Complaint: S.E.C. v. Heinen, Anderson

Separately, SEC enforcers charged Nancy R. Heinen, former general counsel for Apple, with violating anti-fraud laws and misleading auditors at KPMG by signing phony minutes for a board meeting that government lawyers say never occurred.

Heinen, through her lawyer, Miles F. Ehrlich, vowed to fight the charges. Ehrlich said Heinen's actions were authorized by the board, "consistent with the interests of the shareholders and consistent with the rules as she understood them."

Anderson issued an unusual statement defending his reputation and tying Jobs to the scandal in the strongest terms to date. He said he warned Jobs in late January 2001 that tinkering with the dates on which six top officials were awarded 4.8 million stock options could have accounting and legal disclosure implications. Jobs, Anderson said, told him not to worry because the board of directors had approved the maneuver. Regulators said the action allowed Apple to avoid $19 million in expenses. Late last year, Apple said that Jobs helped pick some favorable dates but that he "did not appreciate the accounting implications."

Explaining Anderson's motive for issuing the statement, his lawyer Jerome Roth said: "We thought it was important that the world understand what we believe occurred here."

Roth said his client, a prominent Silicon Valley figure and a managing director at the venture capital firm Elevation Partners, will not be barred from serving as a public-company officer or board member under the settlement, in which Anderson did not admit wrongdoing. Roth declined to characterize the current relationship between Anderson and Jobs.

The SEC charges are the first in the months-long Apple investigation. Jobs was interviewed by the SEC and federal prosecutors in San Francisco, but no charges have been filed against him.

Steve Dowling, a spokesman for Apple, declined to comment on Jobs's conversations with Anderson. Dowling emphasized that the SEC did not "file any action against Apple or any of its current employees."

Government authorities praised Apple for coming forward with the backdating problems last year and for sharing information with investigators. Apple has not publicly released its investigation report.

Continued in article

"SEC charges former Apple executive in options case:  The SEC accuses Apple's former general counsel of fraudulently backdating stock options," by Ben Ames, The Washington Post, April 24, 2007 --- Click Here

The SEC said it did not plan to pursue any further action against Apple itself, which cooperated with the government's probe, but it stopped short of saying its investigation was closed. Commission officials declined to comment on whether possible charges could still be filed against Jobs or other current officers.
"Options troubles at Apple remain despite SEC case against 2 former officers," Associated Press, MIT's Technology Review, April 25, 2007 --- http://www.technologyreview.com/Wire/18587/

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

Bob Jensen's threads on employee stock option accounting under FAS 123 are at
http://www.trinity.edu/rjensen/theory/sfas123/jensen01.htm

Bob Jensen's threads on KPMG's woes are at http://www.trinity.edu/rjensen/Fraud001.htm#KPMG

From The Wall Street Journal Accounting Weekly Review on March 2, 2007

"KPMG Germany's Failure to Spot Siemens Problems Raises Questions" by Mike Esterl, David Crawford, and David Reilly, The Wall Street Journal, Feb 24, 2007, Page: B3 ---
Click here to view the full article on WSJ.com
 

TOPICS: Audit Quality, Auditing

SUMMARY: "German prosecutors say they suspect Siemens employees funneled money through sham consulting contracts into slush funds to bribe potential customers." Part of the evidence may indicate that KPMG failed to investigate questionable items uncovered by a junior auditor. This possibility was documented in statements made by a former executive financial officer of Siemen's telecom equipment unit while imprisoned subsequent to a German police raid of the company's offices. The executive has been released after agreeing to cooperate with authorities and remains a suspect. KPMG Germany has not been charged and has denied any wrongdoing in its auditing practices.

QUESTIONS:
1.) "Despite...alarm bells, KPMG Germany signed off on Siemens's books and the adequacy of its internal controls..." What are the "alarm bells" described in the article that authorities are now saying should have brought potentially fraudulent payments to the attention of Siemens's auditors, KPMG Germany?

2.) What is an auditor's responsibility to detect fraud?

3.) In general, what are an auditor's responsibilities in reporting on a company's internal controls? To verify the types of reports issued, you may examine the Siemens 2005 financial statements filed with the SEC on Form 20-F and referred to in the article http://www.sec.gov/Archives/edgar/data/1135644/000132693205000152/f01125e20vf.htm 

4.) Given that "Siemens, with KPMG Germany's help, identified...($551.8 million) in suspicious transactions spanning seven years and restated its financial results in December," is it possible that KPMG Germany fulfilled its audit obligations identified above? Explain.

5.) What makes it likely that a junior auditor would be the one to uncover questionable practices at a large company? How does a staff auditor's inexperience make it difficult for him or her to exercise judgment on matters examined in an audit?

SMALL GROUP ASSIGNMENT: Allow students to form small groups of two or three. Provide each student with the following statement: Suppose that you are the junior auditor who raised questions about the payments made by Siemens for consulting services, now alleged to be fraudulently reported to cover payments for bribes. Suppose further that you observe that your management letter comment about the matter was removed in "partner review", but that you were convinced there were potentially improper payments you had not investigated during your audit field work. What should you do? Discuss all possible courses of action.

Bob Jensen's threads on audit professionalism and independence are at http://www.trinity.edu/rjensen/fraud001.htm#Professionalism

One of the larger SEC civil penalties for accounting fraud
In one of the largest civil penalties the Securities and Exchange Commission has ever obtained against an individual in an accounting-fraud case, a federal judge has ordered Henry C. Yuen, former chief executive officer of Gemstar-TV Guide International Inc., to pay $22.3 million for his role in a fraud that led the company to overstate revenue by more than $225 million between 2000 and 2002. The ruling comes four years after the SEC launched its investigation of Gemstar, a once highflying Hollywood company that publishes TV Guide magazine and holds patents on technology used for cable- and satellite-television programming guides. Earlier this year following a three-week trial, U.S. District Judge Mariana Pfaelzer found Mr. Yuen liable for securities fraud, lying to auditors and falsifying Gemstar's books.
Jane Spencer and Kara Scannell, "Gemstar Ex-CEO Is Ordered To Pay $22.3 Million:  Henry Yuen's Civil Penalty Is Among Largest Sought By SEC Against Individual," The Wall Street Journal, May 9, 2006; Page A3 --- http://online.wsj.com/article/SB114713467418347300.html?mod=todays_us_page_one
Jensen Comment
The outside auditor was KPMG.

It Just Gets Deeper and Deeper for KPMG

KPMG knew that FAS 91 and FAS 133 were being violated, but KPMG did not insist on correcting the books.  How much of Fannie’s current trouble can be blamed on KPMG?
Fannie's auditor, KPMG, disagreed with the way the company decided how much (derivatives instruments debt and earnings fluctuations) to book in 1998. The matter was recorded as "an audit difference" -- a disagreement between a company and its auditor that doesn't require a change in the books.
John D. McKinnon and James R. Hagerty, "How Accounting Issue Crept Up On Fannie's Pugnacious Chief," The Wall Street Journal, December 17, 2004 --- http://online.wsj.com/article/0,,SB110323877001802691,00.html?mod=todays_us_page_one 
Bob Jensen's Fannie Mae threads are at http://www.trinity.edu/rjensen/caseans/000index.htm 
Bob Jensen’s threads on KPMG’s troubles are at http://www.trinity.edu/rjensen/fraud001.htm#KPMG 

KPMG was eventually fired, due to SEC pressure, from the enormous Fannie Mae audit. 

"New Fannie Mae Violations Surface:  Accounting Flaws Include Possible Overvalued Assets, Insurance to Hide Losses," by Dawn Kopecki, The Wall Street Journal, September 29, 2005; Page A3 --- http://online.wsj.com/article/0,,SB112793973737254864,00.html?mod=todays_us_page_one

Investigators combing through Fannie Mae's finances have found new accounting violations, including evidence that the company may have overvalued assets, underreported credit losses and misused tax credits, according to people close to or previously involved in the inquiries.

Some people familiar with the examination said evidence also indicates the company may have bought so-called finite insurance policies to hide losses after they were incurred. Securities regulators, including New York state Attorney General Eliot Spitzer, are cracking down on corporations that they say bolstered earnings by using abusive financial reinsurance policies that are more akin to loans, where little or no risk is transferred to the insurer.

These people didn't provide details on the new violations, and it isn't clear how much new damage -- if any -- these problems will create for the company. But the people indicated that the alleged new accounting violations were designed to embellish the company's earnings and are in addition to the violations that the company and its regulator have already disclosed.

According to the people who have been involved with or are close to the investigations, for example, there are questions about how Fannie booked certain tax credits, including those used to lower its annual tab with the Internal Revenue Service. Fannie reduced its corporate-tax rate in 2003 from a statutory minimum of 35% to an effective rate of 26% by recording tax savings of $988 million in tax credits and an additional $479 million from its tax-exempt investments, according to its year-end earnings disclosure.

Earlier this year, Fannie Mae acknowledged that it violated accounting principles in recording its derivatives and other transactions, estimating a possible cumulative after-tax loss for the restatement period from 2001 through mid-2004 of as much as $10.8 billion, based on the company's finances as of Dec. 31, 2004. The company has said that its restatement process won't be completed until the second half of 2006.

In a statement released late yesterday, Fannie Mae noted that its regulator, the Office of Federal Housing Enterprise Oversight, has found that the company was "adequately capitalized" at the end of the second quarter. The company also said it believes it is "on track" to reach an Ofheo mandate that it build up its capital to 30% above the normal requirement by the end of this month. Regarding the various investigations, the company said: "We will continue to provide updates through our regulatory filings as issues are identified and resolved."

Ofheo said Fannie's projected surplus over minimum capital requirements "is sufficient to absorb uncertainties in the estimated impact to capital of the [company's] accounting errors, based on current information."

News that investigators may have found new accounting irregularities triggered a selloff in Fannie Mae stock, which dropped 11%, the largest percentage decline since the stock-market crash of 1987. The stock was off $4.99 to $41.71 in 4 p.m. composite trading on the New York Stock Exchange. That is the lowest closing price since July 1997.

The company's board initiated its own review of Fannie's finances after Ofheo accused executives of manipulating accounting rules in a scathing report delivered to the board 12 months ago. Fannie vehemently defended its accounting until the Securities and Exchange Commission sided with Ofheo last December and directed the company to correct errors in its application of two rules under generally accepted accounting principles, or GAAP. Fannie began its multiyear earnings restatement and ousted Chief Executive Franklin Raines and Chief Financial Officer Timothy Howard shortly thereafter.

Continued in article

You can read the following at http://www.trinity.edu/rjensen/caseans/000index.htm

"The Potential Crisis at Fannie Mae," Comstock Funds, August 11, 2005 --- http://snipurl.com/Fannie133

We have no proprietary information about Fannie Mae, but what is publicly known is scary enough. As you may recall, last December the SEC required Fannie to restate prior financial statements while the Office of Federal Oversight (OFHEO) accused the company of widespread accounting regularities that resulted in false and misleading statements. Significantly, the questionable practices included the way Fannie accounted for their huge amount of derivatives. On Tuesday, a company press release gave some alarming hints on how extensive the problem may be.

 

The press release stated that in order to accomplish the restatements, “we have to obtain and validate market values for a large volume of transactions including all of our derivatives, commitments and securities at multiple points in time over the restatement period. To illustrate the breadth of this undertaking, we estimate we will need to record over one million lines of journal entries, determine hundreds of thousands of commitment prices and securities values, and verify some 20,000 derivative prices…”

 

“…This year we expect that over 30 percent of our employees will spend over half their time on it, and many more are involved. In addition we are bringing some 1,500 consultants on board by year’s end to help with the restatement…Altogether, we project devoting six to eight million labor hours to the restatement. We are also investing over $100 million in technology projects to enhance or create new systems related to accounting and reporting…we do not believe the restatement will be completed until sometime during the second half of 2006…”

 

Continued in article

Bob Jensen's threads about Fannie's FAS 133 violations at Fannie Mae at http://www.trinity.edu/rjensen/caseans/000index.htm

Here's another one of those accounting tempered misdeed confessions "Without admitting or denying the allegations"
I wonder if Dennis the Menace got away with these confessions as often as accounting firms and their corporate clients?
I also wonder how KPMG made Citigroup account for this swap under FAS 133?

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

Bob Jensen's threads on KPMG are at http://www.trinity.edu/rjensen/Fraud001.htm#KPMG