The Rise of Corporate Accountability?. Dr. Norman Meonske Kent State University. Dr. Norman Meonske Kent State University. Ohio Council IMA January 30,2003. Are WeDead Yet?. Accounting Profession. Why so many financial statement frauds all of a sudden?. "The Perfect Storm".
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The Rise of Corporate Accountability?
Dr. Norman Meonske
Kent State University
Dr. Norman Meonske Kent State University
Ohio Council IMA January 30,2003
Are WeDead Yet?
"The Perfect Storm"
Good economy was masking many problems
Moral decay in society
Wall Street expectations—rewards for short-term behavior
Nature of accounting rules
"The Perfect Storm"
Greed by investment banks, commercial banks, and investors
Bad Lawyer Advice?
Failure of Corporate Audit Committees
"The Perfect Storm"
Board of Directors Failures and Greed
Financial Analyst Conflict of Interests and Greed
Corporate Accounting Ability Regulation
Good economy was masking problems….
With increasingstock prices, profits and wealth for everyone, no one worried about potential problems.
or Not Go Round
Prints More Money
In Norm We Trust
Detailed Complicated Rules
With Loop Holes Big Enough To Drive A Truck Through
Allows companies and auditors to be extremely creative when not specifically prohibited by standards.
In the U.S., accounting standards are “rules-based” instead of “principles based.”
It is impossible to makes rules for every situation
Revenue recognition approaches,
Other accounting schemes.
Fosters Earning Game
Does Not Show Value Creation
Average compensation of America's top 100 CEOs has risen from 39 times that of the ordinary worker in 1970 to 1,000 times in 1999.
GE had not disclosed those perks -- which included courtside sports tickets, a Manhattan apartment, and use of a corporate jet -- beyond a vague statement in an SEC filing that Welch would have "continued lifetime access to company facilities and services... "
Stock Fell 13% With This Revelation
Former General Electric Chairman
Beat The Numbers
How To Play
Fraudulent Financial Reporting
Creative Accounting Practices
Rewards of The Game
Share Price Effect
Borrowing Cost Effect
Bonus Plan Effect
Political Cost Effect
Multiply the result by negative 1 to make it positive
Buy it anyway
Incentives to commit financial statement fraud are very
strong. Investors want decreased risk and high returns.
Risk is reduced when variability of earnings is decreased.
Rewards are increased when income continuously improves.
Firm A Firm B
Which firm will have the higher stock price?
In a separate case in late September, a judge's divorce ruling unsheathed guarded financial information about accounting firm Ernst & Young, which is a private partnership that does not file public financial reports.
In divorce papers for Ernst & Young chief executive officer Richard S. Bobrow, a 45-page judge's opinion revealed how much the CEO was paid and put a dollar value on the company for the first time, giving competitors a rare peek into the firm's finances.
Annual Salary $ 3 Million
$25 million in salary $US29 million in partnership earnings over the next decade.
Pension worth $1 million a year for life and had access to a corporate jet owned by Ernst & Young and a New York apartment.
$ 24 million to Janet Bobrow
Jan Bobrow makes $ 10 an hour part-time at Central Church of the Nazarene in Lenexa, Kan.
The market lopped a cool $1 billion off Veritas' (VRTS) market cap yesterday when its CFO resigned after revealing he lied about his academic credentials. The fundamental picturehasn't changed—unless the CFO's duplicity extended to the books.
Executives at Vetrias, storage management software maker, found that CEO’s claim to have earned an MBA from Stanford Business School was false.
Financial Statement Fraud Will Destroy Your Shareholder Value
$2 billion drop in
$7 million fraud
IPO Favoritism: Bernie Ebbers ($11 million)
“The goal of this scheme was to ensure that (the company) always met Wall Street’s growing earnings expectations for the company. (The company’s) management knew that meeting or exceeding these estimates was a key factor for the stock price of all publicly traded companies and therefore set out to ensure that the company met Wall Street’s targets every quarter regardless of the company’s actual earnings. During the period ___ to ___alone, management improperly inflated the company’s operating income by more than $500 million before taxes, which represents more than one-third of the total operating income reported by (the company.)”
4. New Zealand
14. United Kingdom
Enron began as a pipeline company in Houston in 1985. It profited by promising to deliver so many cubic feet of gas to a particular utility or business on a particular day at a market price.
Deregulation of electrical power markets, a change due in part to lobbying from senior Enron officials:
Chairman Kenneth L. Lay,expanded Enron into an energy broker, trading electricity and other commodities
RISING POWEREnron became a giant middleman that worked like a hybrid of traditional exchanges. But instead of simply bringing buyers and sellers together, Enron entered the contract with the seller and signed a contract with the buyer, making money on the difference between the selling price and the buying price.
Enron kept its books closed, making it the only party that knew both prices.
THE UNRAVELINGAs its services became more complex and its stock soared, Enron created a constellation of partnerships that allowed managers to shift debt off the books.
• Chewco• Whitewing
Special Purpose Entities (SPEs) (Enron’s principal method of financial statement fraud involved the use of SPEs (Special Purpose Entities))
Enron’s Use of Special Purpose Entities (SPEs)
Special Purpose Entities & Off-Balance Sheet Financing
What is the business purpose?
To transfer risks and losses to someone else
One Enron Example (the “Rhythms” transaction):
Now “Do the Deal”
Role of Andersen
Failed to spot many of Enron’s losses
Kept a whole floor of auditors assigned at Enron year around
Did both external and internal audits
Did they know?
The Document Destruction Chronology
Email message about Document Policy:
To: Michael C. Odom
Date: 10/12/2001 10:53 a.m.
From: Nancy A. Temple
Subject: Document retention policy
It might be useful to consider reminding the engagement team of our documentation and retention policy. It will be helpful to make sure that we have complied with the policy. Let me know if you have any questions.
The Cost of “Bad Press”
Some partnerships' losses would have to be paid for out of Enron stock or cash in 2003, bringing the debts back home. There are indications that Enron executives and its accounting firm, Arthur Andersen, had warnings of problems nearly a year ago. According to a Feb. Andersen considered dropping Enron as a client. In August, Enron Vice President Sherron Watkins wrote an anonymous memo to former Chairman Kenneth L. Lay, detailing reasons she thought Enron "might implode in a wave of accounting scandals."
On Oct. 16, Enron announced a $638 million loss for the third quarter, and Wall Street reduced the value of stockholders' equity by $1.2 billion. Enron announced Nov. 8 that it had overstated earnings over the past four years by $586 million and that it was responsible for up to $3 billion in obligations to various partnerships. A $23 billion merger offer from rival Dynegy was dropped Nov. 28 after lenders downgraded Enron's debt to junk-bond status.
THE INVESTIGATIONDozens of lawsuits have been filed against the company by an array of pension funds. Dozens more are directed at former Chairman Kenneth L. Lay, former CEO Jeffrey Skilling and former Chief Financial Officer Andrew Fastow.
Kenneth L. Lay, former Enron Chairman and CEO (resigned Jan. 23, 2002)
Lay and Enron poured millions of dollars into both political parties, cultivating access and using the entree to lobby Congress, the White House and regulatory agencies for action that was critical to the energy company's spectacular growth. In addition to being one of the single largest financial backers of President George W. Bush's politicalcareer, Lay is also one of the president's friends.
AndrewFastow, former Enron Chief Financial Officer (ousted Oct. 24, 2001)
Fastow was removed as Enron's CFO on Oct. 24, 2001 as the SEC began a probe into conflicts of interest in two partnerships he created and managed. Those partnerships earned him around $30 million in management fees from the deals in addition to his Enron salary.
In early October, Fastow was charged with securities, wire and mail fraud, money laundering and conspiring to inflate Enron's profit
Kopper and his domestic partner, William D. Dodson, reaped $10.5 million based on a $125,000 investment in a partnership called Chewco, according to an investigative report issued by Enron's board of directors.
In August 2002, Kopper pleaded guilty to financial wrongdoing and agreed to surrender $12 million in the first criminal case against a company official.
Jeffrey Skilling, former Enron Chief Executive Officer (resigned Aug. 14, 2001)
Senior Enron executives criticized former CEO Skilling about possible conflicts of interest in two partnerships he created with former Chief Financial Officer Andrew Fastow. Jeffrey McMahon, then Enron's treasurer, was "highly vexed" about the conflicts, "complained mightily" and suggested a list of remedies.
Clifford Baxter, former Enron Vice Chairman (resigned May 2, 2001)
Baxter was one of 29 former and current Enron executives and board members named as defendants in a federal lawsuit, after he sold 577,436 shares of Enron for $35.2 million before Enron's collapse.
He was found shot to death in a car Jan. 15, 2002, in an apparent suicide.
Watkins is the internal whistleblower who in August of 2001, more than two months before Enron disclosed it had overstated its profits and understated its debts, warned Kenneth L. Lay that the company might "implode in a wave of accounting scandals." Shortly after Enron Chief Executive Officer Jeffrey Skilling suddenly resigned. Watkins described "a veil of secrecy" around partnerships involving the energy-trading company's former chief financial officer, Andrew Fastow
Arthur AndersenThe job of Arthur Andersen, one of the nation's largest accounting firms, was to make sure investors could rely on Enron's financial statements. But Andersen also was a major business partner-soliciting and selling millions in consulting services to Enron. Andersen was also responsible for some of Enron's internal bookkeeping, and some Andersen executives ended up taking jobs at Enron.
Led by then-chief executive Joseph F. Berardino, Arthur Andersen took its case public, saying it would take "all appropriate steps" to defend its integrity. Berardino also suggested that the company might stop selling consulting services to firms it audits. Barardino has since resigned from the firm.
EmployeesThousands of Enron employees, many with similar skills, were left unemployed. Enron encouraged employees to invest in the company, matched their 401(k) contributions with company stock, and briefly froze the plan in late October, barring employee sales, before the stock's final plunge. Thousands of employees and retirees have next to nothing in theiraccounts.
BanksOne of Enron's biggest lenders, J.P. Morgan Chase, announced losses of $456 million as of Jan. 2002 related to Enron's demise. Citigroup recorded $228 million as of Jan. 2002 in Enron-related losses. But banks and regulators said the overall impact would be minimal, because no one bank is overinvested in Enron.
InvestorsEnron's stock lost nearly all its value, dropping from almost $34 on Oct. 16, 2001. Billions of dollars in stock value were erased. The stock has been delisted from the New York Stock Exchange.
PoliticiansSeveral prominent politicians from both parties returned Enron contribution money to the company or contributing it to charity. Others have been asked about their relationships with Enron.
Its reputation was badly damaged. Divisions of the business have been sold to other companies. There is also the possibility of staggering liability claims.
And Now there are 4
SEC files suit against KPMG and partners over Xerox Accounting
They have been charged with allowing Xerox to report false financial results between 1997 and 2000, rather than risk losing a key audit client. Office equipment maker Xerox last June was forced to restate more than US 6 Billion in revenues over 5 years after regulators accused it of using accounting tricks to prop up its earnings.
Specifically, KPMG offered a detailed description of events as they unfolded in the Xerox case and argued that it did the "right thing" by refusing to sign off on the company's 2000 financial statements in the face of what it called "strong client resistance."
• FBI Agent Coleen Rowley, who called the bureau on the carpet for ignoring evidence hinting at the September 11 terrorist attacks.
Former Enron vice president Sherron Watkins, whose memos warning company chairman Ken Lay about accounting irregularities failed to stop Enron's collapse.
Cynthia Cooper, a WorldCom vice president who told the company's board of directors about nearly $4 billion in accounting irregularities.
John Rigas (former CEO)
The founder and former head of Adelphia, and two of his sons have been charged with looting the nation's No. 6 cable company to pay for luxury condos, a golf course and to cover personal investment losses.
Sam Waksal (former CEO)The former CEO of ImClone was arrested earlier this month on charges of insider trading for allegedly trying to sell hiscompany's stock and tipping off family members after learning of the impending FDA decision on its newcancer drug Erbitux.
Martha StewartA close friend of Sam Waksal, has repeatedly denied any wrongdoing in selling nearly 4,000 ImClone shares on Dec. 27, a day before federal regulators said they would not consider the drugmaker's application for its new cancer drug.ImClone's shares plummeted after the news came out.
Boo Hoo I Lost $400 Million
Dennis Kozlowski (former CEO)Pleads innocent to charges of evidence tampering after earlier pleading the same to charges of evading taxes on purchases of valuable paintings.
--Dennis Kozlowski, the CEO until he was indicted and resigned in June, borrowed more than $40 million from the company, and the loans were later forgiven, reports the Wall Street Journal. The SEC rules governing disclosure of CEO pay are quite clear on those matters, and there is simply no way to avoid disclosing the forgiveness of such loans. Yet Tyco never did. The company neither confirms nor denies any of this, declining to comment pending thecompletion of an internal investigation.
Some of the organizations involved: Merrill Lynch, Chase, J.P. Morgan,
Union Bank of Switzerland, Credit Lynnaise, Sumitomo, and others.
Fraud Losses Reduce Net Income $ for $
If Profit Margin is 10%, Revenues Must Increase by 10 times Losses to Recover Affect on Net Income
Losses……. $1 Million
Fraud Robs Income
Expenses 90 90%
Net Income$ 10 10%
Remaining $ 9
To restore income to $10, need $10 more dollars of revenue to generate $1 more dollar of income.
$436 Million Fraud
Profit Margin = 10%
$4.36 Billion in Revenues Needed
At $20,000 per Car, 218,000 Cars
$100 Million Fraud
Profit Margin = 10 %
$1 Billion in Revenues Needed
At $100 per year per Checking Account, 10 Million New Accounts
We have asked them to memorize, not think
Professors assign homework problems similar to examples used in class, examples in textbooks, and problems on examinations.
Technology has changed everything
Fraudulent Financial Statements
The common element is deceit!
Prohibits Disciplining or Discriminating against employees who provide information regarding securities law violations
Attorney Professional Conduct
Requires Attorney’s to Report Material Violations of Securities or Breaches of Fiduciary Duty to the Company’s CEO or Chief Legal Officer or if necessary to the Board of Directors
New and Increased Felonies + Civil Action
Destruction of ofDocuments
Longer Periods For Civil Fraud
Increased Criminal Penalties
Lower Thresholds To Bar for Unfitness
No Bankruptcy Discharge of Securities Law Liability
Rotation of Audit/Review Partners every 5 years
Prohibits Some Non Audit Services
Expanded 8 K Disclosures
Accelerated 8 K Reporting – 2 Days
New Issuer Fees
SEC Adopt Principles-based Accounting System
Unlawful to Fraudulently Influence Auditors
New Rules for Financial Experts on Audit Committee
New Management Assessment of Internal Control
Non-US Companies Not Exempt
New CEO/CFO Apply To Foreign Private Issuers
NYSE and NASDAQ
Have Made Proposals For the SEC To Consider
Material Off-Balance Sheet Transactions
Reconciliation of Pro Form F/S
SEC Review – 3 Years
“Real Time” Disclosures of Material Changes To Financial Condition
Accelerated Due Dates For Periodic Reports
MD&A Disclosures of Critical Accounting Policies
Detailed Quantitative & Qualitative Matters – No Boilerplate
Security Transactions Including Preplanned Purchase/Sale
The SEC Sets New Ground Rules on
Selective Disclosure & Insider Trading
CEO/CFO Certification and Disclosure Process
Corporate Code of Ethics
Enhanced Audit Committee
Forfeiture of Bonuses, and Stock Incentives For Restatements Due to Misconduct
Majority of Directors Must Be Independent
Once The Camel Stick Its Head In the Tent, We Will Have Problems
The Sarbanes-Oxley Act apparently did not go far enough to suit California lawmakers.
Under a law that took effect this month, public companies based in California or doing business there have to give the state extra layers of detail on insider activity.
Key Elements of Public Trust
Spirit of Transparency
Culture of Accountability
People of Integrity