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8/7/2019 Issues o Accounting Fraud
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Accounting UpdatesAccounting Updates
Southern GasSouthern GasAssociationAssociation Accounting & FinancialAccounting & FinancialExecutives ConferenceExecutives Conference
April 28, 2003April 28, 2003
Robert E. (Bob) JensenRobert E. (Bob) Jensen
Trinity UniversityTrinity UniversitySan Antonio, TX 78212San Antonio, TX 78212http://www.trinity.edu/rjensenhttp://www.trinity.edu/rjensen
//
Accounting UpdatesAccounting Updates
Southern GasSouthern GasAssociationAssociation Accounting & FinancialAccounting & FinancialExecutives ConferenceExecutives Conference
April 28, 2003April 28, 2003
Robert E. (Bob) JensenRobert E. (Bob) Jensen
Trinity UniversityTrinity UniversitySan Antonio, TX 78212San Antonio, TX 78212http://www.trinity.edu/rjensenhttp://www.trinity.edu/rjensen
//
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Why so many financial statementWhy so many financial statement
frauds all of a sudden?frauds all of a sudden?
Systemic Problems of Accounting That Cannot or
Will Not Be Solved:http://www.trinity.edu/rjensen/FraudConclusion.htm
Behavior of CPA Firms:http://www.trinity.edu/rjensen/fraud.htm
Greed on Wall Street: Rotten to the Corehttp://www.trinity.edu/rjensen/fraud.htm#Cleland
Washington DC Prostitutes:Representative Fernand St Germain (D-Rhode Island) $32 Billion for 30 Years
Senator Phil Gramm (R-Texas) & Wife Wendy $400 billion and counting
http://www.trinity.edu/rjensen/fraud.htm#WarningSigns
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Why so many financial statementWhy so many financial statement
frauds all of a sudden?frauds all of a sudden?
Good economy was masking many problemsGood economy was masking many problems
Moral decay in society
Executive incentives
Wall Street expectationsrewards forshort-term behavior
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Why so many financial statementWhy so many financial statement
frauds all of a sudden?frauds all of a sudden?
Failure of Corporate Audit Committees
Board of Directors Failures and Greed
Financial Analyst Conflict of Interests and Greed:Rotten at the Core
Education Failures:Graduates of Greed Rather Than Professionalism
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Good economy wasGood economy was
masking problemsmasking problems..
With increasing stock prices,profits and wealth for
everyone, no one worriedabout potential problems.
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Detailed Complicated RulesDetailed Complicated Rules
With Loop Holes Big EnoughTo Drive A Truck Through
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Nature of Accounting RulesNature of Accounting Rules
Allows companies and auditors to beextremely creative when notspecifically prohibited by standards.
rules-based vs. principles basedrhetorical nonsense
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Loop Hole Examples Include:
SPEs and other types ofoff-
balance sheet financing
Pension accounting
Merger reserves
Other accounting schemes.
Revenue recognition approaches,
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When the client pushes,without specific rules in everysituation, there is no room for
the auditors to say, You cantdo thisbecause it isnt
GAAP
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UnaccountableUnaccountable
ContractsContracts
Expect New Amendments in SFAS 149
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GAAPCRITICISM
Fosters Short-Term Earnings Manipulations
Does Not Show Value Creation
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Executive IncentivesExecutive IncentivesMeeting Wall Streets ExpectationsMeeting Wall Streets Expectations
Performance is based on earnings & stock price
Focus is on short-term (quarterly) performance only
Stock prices are tied to meeting Wall Streetsearnings forecasts
Companies are heavily punished fornot meeting forecasts
Moral Hazard: Employee Stock OptionsDid you ever hear the name Lou Pai?
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GE had not disclosed those perks -- which includedcourtside sports tickets, a Manhattan apartment, anduse of a corporate jet -- beyond a vague statement inan SEC filing that Welch would have "continuedlifetime access to company facilities and services..."
Jack Welch,Former GeneralElectric Chairman
Stock Fell 13%With ThisRevelation
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Enrons CEO of Enron Broadband Services, Ken
Rice, had a $33,000 customized Hellcat motorcyclein his office just for a distinctive decoration.
Lou Pai, CEO of Energy Services was such abig shot that he refused to commute to
Houstons IntercontenentalAirport to boardEnrons corporate jets. A Falcon 900 jet hadto be dispatched to his home in the Houston
suburb of SugarL
and.
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How To Play
Numbers Game
Aggressive AccountingAggressive Accounting
Earnings ManagementEarnings Management
Income SmoothingIncome SmoothingFraudulent Financial ReportingFraudulent Financial Reporting
CreativeAccountingPracticesCreativeAccountingPractices
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Rewards ofRewards of
The GameThe Game
Share Price EffectShare Price Effect
Borrowing CostEffectBorrowing CostEffect
Bonus Plan EffectBonus Plan Effect
Political CostEffectPolitical CostEffect
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How to value a dot.com company:
Take the reported pro forma lossfor the year
Multiply the result by negative 1 tomake it positive
Multiply that number by at least 100If stock price is less than theresultBuy, If Not?
Buy it anyway
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Incentives for F.S. FraudIncentives for F.S. Fraud
Incentives to commit financial statement fraud are very
strong. Investors wantdecreased riskand high returns.
Risk is reduced when variability of earnings is decreased.
Rewards are increased when income continuously improves.
Which firm will have the higher stock price?
Firm A Firm B
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AuditorsAuditorsthe CPAsthe CPAs Failed to accept responsibility for fraud detection (SEC, Supreme
Court, public expects them to detect fraud) If auditors arent thewatchdogs, then who is?
Tradition of sending puppies out to yap at the receivables
A few auditors got too close to their clients
Audit became a loss leader
Easier to sell lucrative consulting services from the inside
Became largest consulting firms in the U.S. very quickly (Andersen
Consulting grew to compete with Accenture
Became greedy--$500,000 per year per partnercompensation wasnt enough; saw everyone else getting rich
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In a separate case in late September, a judge'sdivorce ruling unsheathed guarded financialinformation about accounting firm Ernst & Young,which is a private partnership that does not filepublic financial reports.
In divorce papers for Ernst & Young chiefexecutive officer Richard S. Bobrow, a 45-pagejudge's opinion revealed how much the CEO waspaid and put a dollar value on the company forthe first time, giving competitors a rare peek intothe firm's finances.
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Annual Salary $ 3 Million
$25 million in salary $US29 million inpartnership earnings over the nextdecade.
Pension worth $1 million a year for life andhad access to a corporate jet owned byErnst & Young and a New York apartment.
$ 24 million to Janet Bobrow
Jan Bobrow makes $ 10 an hour part-time atCentral Church of the Nazarene in Lenexa, Kan.
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Moral DecayMoral Decay
Attendees at the April, 1998 Business Week Forumof Chief Financial Officers revealed:
67% of CFOs said they had been asked bysenior company executives to misrepresentcorporate financial results
12% of CFOs admitted they had actuallymisrepresented financial results55% said theyhad fought off requests to cook the books
Honesty studies1961: 12%
1986: 31%
2002: ???
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How Much Stanford MBA Worth?
a. $500,000 dollars
b. $ 10 Million dollars
c. $ 100 Million dollars
d. $ 1 billion dollars
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The market lopped a cool $1 billion off Veritas' (VRTS)
market cap yesterday when itsCFO resigned afterrevealing he lied about his academiccredentials. The fundamental picture
hasn't changedunless the CFO'sduplicity extended to the books.
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Executives at Vetrias,
storage managementsoftware maker, found that
CEOs claim to haveearned an MBA from
Stanford Business Schoolwas false.
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Financial StatementFraud Will Destroy YourShareholder Value
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Financial Statement FraudFinancial Statement Fraud
Financial statement fraud causes adecrease in market value of stock ofapproximately 500 to 1,000 times theamount of the fraud.
$7 million fraud $2 billion drop instock value
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These Are Interesting TimesThese Are Interesting Times
Number and size of financial statement frauds are
increasing
Number and size of frauds against organizationsare increasing
Some recent frauds involve several peopleasmany as 20 or 30 (seems to indicate moral decay)
M
any investors have lost confidence in credibility offinancial statements and corporate reports
More interest in fraud than ever beforenow acourse on many college campusesfrom 3 or 4 to
over 50 college campuses
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Current Executive FraudCurrent Executive Fraud--Related ProblemsRelated Problems
Misstating Financial Statements: Quest,Enron, Global Crossing, WorldCom, etc.
Executive Loans and Corporate Looting: John
Rigas (Adelphia), Dennis Kozlowski (Tyco--$170millionthe $15,000 umbrella stand)
IPO Favoritism: Bernie Ebbers ($11 million)
CEO Retirement Perks: Delta, PepsiCo,AOL Time Warner, Ford, GE, IBM(Consulting Contracts, Use of CorporatePlanes, Executive Apartments with meals,maids etc.
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Current Executive FraudCurrent Executive Fraud--RelatedRelatedProblemsProblems
ExorbitantStock Optionsfor Executives
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Complaint in Fraud CaseComplaint in Fraud Case
Several hundred million in earnings overstatement Complaint:
The goal of this scheme was to ensure that (the
company) always met Wall Streets growing earningsexpectations for the company. (The companys)management knew that meeting or exceeding theseestimates was a key factor for the stock price of allpublicly traded companies and therefore set out toensure that the company met Wall Streets targets everyquarter regardless of the companys actual earnings.During the period ___ to ___alone, managementimproperly inflated the companys operating income bymore than $500 million before taxes, which representsmore than one-third of the total operating income
reported by (th
e company.)
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Complaint in Fraud CaseComplaint in Fraud Case
The participants in the illegal schemeincluded virtually the entire seniormanagement of (the company), including
but not limited to its former chairman andchief executive officer, its formerpresident, two former chief financialofficers and various other senior
accounting personnel. In total, there wereover 20 individuals involved in theearnings overstatement schemes.
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Fraud InternationallyFraud Internationally
1. Denmark
2. Finland
3. Sweden
4. New Zealand
5. Canada
6. Netherlands
7. Norway
8. Australia
13 Germany
14. United Kingdom
16. U.S.A.
36. Brazil
40. Philippines
47. Mexico
49. Russia
52. Nigeria
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Largest Bankruptcy FilingsLargest Bankruptcy Filings(1980 to Present)(1980 to Present)
Company Assets (Billions) When Filed1. WorldCom $101.9 July, 2002
2. Enron $63.4 Dec., 2001
3. Texaco $35.9 April, 1987
4. Financial Corpof America
$33.9 Sept., 1988
5. Global Crossing $25.5 Jan., 2002
6. Adelphia $24.4 June, 20027. PG&E $21.5 April, 2001
8. MCorp $20.2 March, 1989
9. Kmart $17.0 Jan., 2002
10. NTL $16.8 May, 2002
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Recent Financial StatementRecent Financial Statement
FraudsFrauds
Enron
WorldCom
Adelphia Global Crossing
Xerox
Qwest Many others
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Enrons Use of SpecialEnrons Use of SpecialPurpose Entities (SPEs)Purpose Entities (SPEs)
To hide bad investments and poor-performing assets(Rhythms Net Connections). Declines in value of assetswould not be recognized by Enron (Market to Market.)
Earnings managementBlockbuster Video deal--$111
million gain (Bravehart, LJM
1 and Chewco) Quick execution of related-party transactions at desiredprices. (LJM1 and LJM2)
To report over $1 billion of false income To hide debt (Borrowed money and not put on financial
statements of Enron) To manipulate cash flows, especially in 4th quarters Many SPE transactions were timed (or illegally back-
dated) just near end of quarters so that income could bebooked just in time and in amounts needed, to meetinvestor expectations
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What is the business purpose?To transfer risks and losses to someone else
One Enron Example (the Rhythms transaction): Enron holds Internet stock in company called Rhythms NetConnections Stock is restricted (cant be sold for a certain period of time Enron doesnt want exposure to risk of a price drop The solution is simple! Find someone else who believes the Rhythms stock
price will rise and is willing to sell a contract (a put option) to buy the stock in
the future at a set price (a hedge!) The problem is that Enron cant find anyone willing to do the deal Another simple solution! Start a company (a Special Purpose Entity or SPE) to
take the other side of the transaction (Enron called it LJM1) Where does the financing come from?
97% from bank loan Guaranteed with Enron stock 3% from entity other than Enron Andrew Fastow and others!
Now Do the Deal Enron gives $168 million in Enron shares to LJM1 (LJM1s primary asset) LJM1 gives Enron a note for $64 million and a put option valued at $104 million When everything settles out, Fastow receives $15 million for his $1 million
investment Enron gets to hedge (i.e., not report) a $103 million market loss on its stock
investment
Special Purpose Entities & OffSpecial Purpose Entities & Off--Balance Sheet FinancingBalance Sheet Financing
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LJM1 SPELJM1 SPE
Responsible for 20% of SPE restatement or$100 millionShould have been consolidatedan error injudgment by Andersen (per Andersen)
After Andersens initial review in 1999, Enroncreated a subsidiary within LJM1, referred toas Swap Sub. As a result, the 3% rule forresidual equity was no longer met.
Andersen was reviewing this transactionagain at the time problems were madepublicinvolved complex issues concerningthe valuation of various assets and liabilities.
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The Chewco SPEThe Chewco SPE
Accounted for 80% of SPE restatement or $400 millionhidlosses
In 1993, Enron and the California Public EmployeesRetirement System (Calpers) formed a 50/50 partnershipJoint Energy Development Investments Limited (JEDI)
In 1997, Enron bought out Calpers interest in JEDI Chewco Financing
$240 million loan from Barclays, guaranteed by Enron $132 million loan from JEDI $11.4 million loan from Barclays; called Equity
$0.1 million from Enron employee Financial reward to Enron employee
$2 million management fee over 3 years (remained full-time Enron employee)
$10 million liquidation ($125K investment)
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LJM2 SPELJM2 SPERaptors IRaptors I--IVIV
Established by Enron CFO to provide a quickbuyer for Enron assets
By December 2000, $1.5 billion in hedged
investments, $500 million Enron gain Financial reward to Enron CFOat least $15
million
Enron Financial Statement ImpactHedged $1billion in losses over 5 quarters; reportedearnings of $1.5 billion.
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Insufficient Disclosure.Insufficient Disclosure.2000 Proxy Statement During 2000, certain Enron
subsidiariesentered into a number of transactionswith LJM2 Co-InvestmentAndrew S. Fastow,Executive Vice President and Chief Financial Officer ofEnron, is the managing member of LJM2s generalpartner.
Paragraph outlining the transactions
These transactions occurred in the ordinary course of
Enrons business and were negotiated on an armslength basis with senior officers of Enron other than Mr.Fastow. Management believes that the terms of thetransactions were reasonable and no less favorablethan the terms of similar arrangements with unrelated
third parties.
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Fastows Explanation of Partnerships (SPEs)Fastows Explanation of Partnerships (SPEs)
The partnerships were used for unbundlingand reassembling the various components ofa contract. We strip out price risk, we strip
out interest rate risk, he said. Whats leftmay not be something that we want.
The obvious question is Why would anyone
want whatever was left?
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Was paid $52 million in 2000, themajority of which was for non-auditrelated consulting services.
Role of AndersenRole of Andersen
Failed to spot many of Enrons losses
Kept a whole floor of auditors
assigned at Enron year aroundEnron was Andersens second largest client
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Did both external and internal audits CFOs and controllers were former
Andersen executives
Accused of document destructionwas criminally indicted Went out of business
One Partner I had $4 million in myretirement account and lost it all.Some partners who transferred toother firms now have two equity loans
and no retirement savings.
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Where was Anderson?Where was Anderson?
Did they know? 2/5/01: Andersen partners meet to discuss Enrons accounting, related parties,
fees, etc.
Issue: For a significant amount of time, according to notes of the meeting, theAndersen accountants debated a critical point: What should they do about twoSPEs, LJM1 and LJM2, that had been set up 18 months earlier by Fastow?
Resolution: They drew up a "to do" list: Recommend a special committee of the Board to review LJM deals. Review the SPE accounting tests.
2/12/01: The Big Meeting: Andersen partners meet with Enron board's audit andcompliance committee.
All Enron executives were excused from the room. And then..no evidence of any discussion Interesting side note: From 1997 to 2001, Enron paid Andersen $5.7 million in
connection with work performed specifically on the LJM and Chewco transactions.
Enrons AuditCommittee
Enrons ExecutivesAuditor
(Arthur Andersen)
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Anderson ShreddingAnderson ShreddingThe Document Destruction Chronology October 12 Nancy Temple sends Document retention policy email to Michael
Odom. October 17 SEC asks Enron for information about its accounting. October 23 David Duncan calls urgent meeting, organizes effort to shred and
dispose. The topics of discussion, according to a typed agenda, included: "SEC probe/shareholder lawsuits" and
"soft and hard copy file review." November 8 Andersen receives subpoena from SEC. November 9 Duncans assistant sends email to secretaries: no more
shredding.
Email message about Document Policy:To: Michael C. OdomDate: 10/12/2001 10:53 a.m.From: Nancy A. TempleSubject: Document retention policyMike-It might be useful to consider reminding the engagement team of our documentation andretention policy. It will be helpful to make sure that we have complied with the policy. Let
me know if you have any questions.Nancy
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The Cost of Bad PressThe Cost of Bad Press
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Some partnerships' losses would have to bepaid for out of Enron stock or cash in 2003,
bringing the debts back home. There areindications that Enron executives and itsaccounting firm, Arthur Andersen, hadwarnings of problems nearly a year ago.
According to a Feb. Andersen considereddropping Enron as a client. In August,Enron Vice President Sherron Watkins wrotean anonymous memo to former Chairman
Kenneth L. Lay, detailing reasons shethought Enron "might implode in a wave ofaccounting scandals."
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On Oct. 16, Enron announced a $638million loss for the third quarter, and Wall
Street reduced the value of stockholders'equity by $1.2 billion. Enron announcedNov. 8 that it had overstated earnings over
the past four years by $586 million andthat it was responsible for up to $3 billion
in obligations to various partnerships.A $23 billion merger offer from rivalDynegy was dropped Nov. 28 after lendersdowngraded Enron's debt to junk-bondstatus.
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THE INVESTIGATIONDozens of lawsuits have been filedagainst the company by an array
of pension funds. Dozens moreare directed at former ChairmanKenneth L. Lay, former CEO
Jeffrey Skilling and former ChiefFinancial Officer Andrew Fastow.
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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, theWhite House and regulatory agencies for action that was critical tothe energy company's spectacular growth. In addition to being oneof the single largest financial backers of President George W.
Bush's politicalcareer, Lay is also one of the president'sfriends.
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Greed
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Fastow was removed as Enron's CFO on Oct. 24,2001 as the SEC began a probe into conflicts ofinterest in two partnerships he created andmanaged. Those partnerships earned him around
$30 million in management fees from the deals inaddition to his Enron salary.
AndrewFastow, formerEnron ChiefFinancial
Officer (ousted Oct. 24,2001)
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In early October, Fastow wascharged with securities, wireand mail fraud, moneylaundering and conspiring toinflate Enron's profit
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Kopper and his domestic partner, WilliamD. Dodson, reaped $10.5 million based
on a $125,000 investment in apartnership called Chewco, according toan investigative report issued by Enron'sboard of directors.
In August 2002, Kopper pleaded guiltyto financial wrongdoing and agreed to
surrender $12 million in the first criminalcase against a company official.
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Senior Enron executives criticized former CEOSkilling about possible conflicts of interest in twopartnerships he created with former ChiefFinancial Officer Andrew Fastow. JeffreyMcMahon, then Enron's treasurer, was "highlyvexed" about the conflicts, "complained mightily"and suggested a list of remedies.
Jeffrey Skilling, former Enron ChiefExecutive Officer (resigned Aug. 14,
2001)
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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 afederal lawsuit, after he sold 577,436 shares of Enron for$35.2 million before Enron's collapse.
He was found shot to death in acar Jan. 15, 2002, in an apparentsuicide.
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Watkins is the internal whistleblowerwho in August of 2001, more than twomonths before Enron disclosed it had
overstated its profits and understated itsdebts, warned Kenneth L. Lay that thecompany might "implode in a wave ofaccounting scandals." Shortly after
Enron Chief Executive Officer JeffreySkilling suddenly resigned. Watkinsdescribed "a veil of secrecy" aroundpartnerships involving the energy-trading company's former chief financial
officer, Andrew Fastow
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Arthur Andersen
The job of Arthur Andersen, one of the nation'slargest accounting firms, was to make sureinvestors could rely on Enron's financialstatements. But Andersen also was a major
business partner-soliciting and selling millions inconsulting services to Enron. Andersen was alsoresponsible for some of Enron's internalbookkeeping, and some Andersen executivesended up taking jobs at Enron.
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Led by then-chief executive Joseph F.Berardino, Arthur Andersen took its casepublic, saying it would take "allappropriate steps" to defend its integrity.
Berardino also suggested that thecompany might stop selling consultingservices to firms it audits. Barardino has
since resigned from the firm.
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EmployeesThousands of Enron employees, many withsimilar skills, were left unemployed. Enron
encouraged employees to invest in thecompany, matched their 401(k) contributionswith company stock, and briefly froze the planin late October, barring employee sales, before
the stock's final plunge. Thousands ofemployees and retirees have next to nothingin their accounts.
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THE IMPACTTHE IMPACT
BanksOne of Enron's biggest lenders, J.P. MorganChase, announced losses of $456 million as of
Jan. 2002 related to Enron's demise. Citigrouprecorded $228 million as of Jan. 2002 inEnron-related losses. But banks andregulators said the overall impact would be
minimal, because no one bank is overinvestedin Enron.
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THE IMPACTTHE IMPACT
InvestorsEnron's stock lost nearly all its value,
dropping from almost $34 on Oct. 16,2001. Billions of dollars in stock value wereerased. The stock has been delisted fromthe New York Stock Exchange.
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THE IMPACTTHE IMPACT
Politicians
Several prominent politicians from
both parties returned Enroncontribution money to the company orcontributing it to charity. Others have
been asked about their relationshipswith Enron.
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THE IMPACTTHE IMPACT
Arthur AndersenIts reputation was badly damaged. Divisions of
the business have been sold to other companies.There is also the possibility of staggering liabilityclaims.
And Now there are 4
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SEC files suit against
KPMG and partners overXerox Accounting
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They have been charged withallowing Xerox to report falsereport false
financial resultsfinancial results between 1997 and2000, rather than risk losing a keyaudit client. Office equipment maker
Xerox last June was forced to restatemore than US 6 Billion in revenuesover 5 years after regulators
accused it of using accountingaccountingtrickstricks to prop up its earnings.
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Specifically, KPMG offered adetailed description of events as
they unfolded in the Xerox caseand argued that it did the "rightthing" by refusing to sign off on
the company's 2000 financialstatements in the face of what itcalled "strong client resistance."
Response
FBI Agent Coleen Rowley,
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g y,who called the bureau onthe carpet for ignoringevidence hinting at theSeptember 11 terroristattacks.
Former Enron vice presidentSherron Watkins, whose memos
warning company chairman KenLay about accountingirregularities failed to stopEnron's collapse.
Cynthia Cooper, a
WorldCom vice presidentwho told the company'sboard of directors aboutnearly $4 billion inaccounting irregularities.
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$10 BillionExpenses
Treated As
Assets
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The founder and former head ofAdelphia, andtwo ofhissonshave beenchargedwith looting
thenation's No. 6 cablecompanyto pay for luxury condos, a golfcourse andto cover personal
investment losses.
John Rigas (former CEO)
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Sam Waksal (former CEO)
The former CEO of ImClonewas arrested earlier thismonth on charges of insidertrading for allegedly trying
to sell his company's stockand tipping off familymembers after learning of
the impending FDA decisionon its new cancer drug Erbitux.
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Martha StewartA close friend of Sam Waksal, has
repeatedly denied any wrongdoing inselling nearly 4,000 ImClone shares onDec. 27, a day before federal regulatorssaid they would not consider the
drugmaker's application for its newcancer drug.ImClone's sharesplummeted after the news came out.
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Boo Hoo
I Lost$400Million
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Dennis Kozlowski (formerCEO)Pleads innocent to charges ofevidence tampering after
earlier pleading the same tocharges of evading taxes onpurchases of valuablepaintings.
--DennisKozlowski, the CEO until he
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,was indicted and resigned in June,borrowed more than $40 million from thecompany, and the loans were laterforgiven, reports the Wall Street Journal.The SEC rules governing disclosure of CEO
pay are quite clear on those matters, andthere is simply no way to avoid disclosingthe forgiveness of such loans. Yet Tyconever did. The company neither confirmsnor denies any of this, declining tocomment pending the completion of aninternal investigation.
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Sample FraudsSample Frauds
Large Fraud of $2.6Billion over 9 years Year 1 $600K
Year 3 $4 million
Year 5 $80 million
Year 7 $600 million
Year 9 $2.6 billion
In years 8 and 9, four of
the worlds largest bankswere involved and lostover $500 million
0
500,000,000
1,000,000,000
1,500,000,000
2,000,000,000
2,500,000,000
3,000,000,000
Year1 Year3 Year5 Year 7 Year 9
Some of the organizations involved: Merrill Lynch, Chase, J.P.Morgan,Union Bank of Switzerland, Credit Lynnaise, Sumitomo, and others.
Wh F d i C tl B i P bl th tWh F d i C tl B i P bl th t
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Why Fraud is a Costly Business Problem thatWhy Fraud is a Costly Business Problem that
must be addressed by corporate executivesmust be addressed by corporate executives
Fraud Losses ReduceNet Income $ for $
If Profit Margin is 10%,Revenues Must Increase
by 10 times Losses toRecover Affect on NetIncome Losses. $1 Million
Revenue.$1 Billion
Fraud Robs Income
Revenues $100 100%Expenses 90 90%Net Income $ 10 10%Fraud 1Remaining $ 9
To restore income to $10, need$10 more dollars of revenue togenerate $1 more dollar ofincome.
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Fraud CostTwo ExamplesFraud CostTwo Examples
General Motors
$436 Million Fraud
Profit Margin = 10%
$4.36 Billion inRevenues Needed
At $20,000 per Car,218,000 Cars
Bank
$100 Million Fraud
Profit Margin = 10 %
$1 Billion in RevenuesNeeded
At $100 per year perChecking Account,10 Million NewAccounts
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EducatorsEducators Havent taught ethics enough (cant
make up own rules to meet own needs
Need to teach students about fraudneed
a fraud course Need to teach studentshow to think
Need to teach students how to think
We have taught them how to copy, not think
We have asked them to memorize, not think
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EducatorsEducators
We have done what is easiest for us andeasiest for our students
Accounting Education and LearningAccounting Education and Learning
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Accounting Education and LearningAccounting Education and LearningTheoryTheory
BehavioristApproach Learners are seen as empty vessels that
instructors pour knowledge intoProfessors use primarily lecture-based teaching
Students are provided with information needed toproduce the desired behaviorhigh scores oncontent-based examinations.
Professors assign homework problems similar
to examples used in class, examples intextbooks, and problems on examinations.
Accounting Education and LearningAccounting Education and Learning
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Accounting Education and LearningAccounting Education and LearningTheoryTheory
Students use text orlecture notes asguides and solutionsmanuals.
Students need not define theproblem or understand why
something is done the way it is orwhat other alternatives areavailableonly how something isdone.
Problems withProblems with
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Problems withProblems withAccounting EducationAccounting Education
1. Teach outdated stuffreplaced by
technologyteach to the past, not the future
2. Too narrow and specialized3. 150-hour programsmore of the same
4. Ph.D. programs reinforce specialization
5. Dont cover important topics in the right ways
a. Globalization
b. Technology
c. Various business models
Problems withProblems with
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Problems withProblems withAccounting EducationAccounting Education
1. Rule-based, memorization, test-for-content,
prepare for certification model, doesnt add
significant value
2. Does not expose students to ambiguity enough
3. Lacks creativity
a. Not enough teaching of skills
b. Not enough out-of-classroom activities
c. Not enough focus on technology
Technology has changed everything
What are we teaching ourWhat are we teaching our
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What are we teaching ourWhat are we teaching ourstudents?students?
One of the main things we are teaching is how to copy. Not from a solutions manual or from other students (because
that is prohibited), but from examples in the chapter or fromother students.
Students are not developing higher-level thinking skills or
learning to identify issues or define unstructured problems. When they graduate and find themselves performing an audit orcompleting a tax return, they do what we taught them to do--theyreference what was done last year (a similar example) and copy(with different numbers and slight changes in format)
They dont think analytically about what has changed or even
what is going on They dont consider what the risks and substance of transactionsare, or what changes in the numbers mean.
They are copying because we taught them how to copy
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Educational FocusEducational Focus
Is it because this type of teaching iseasier to teach and much easier to
assess?
Why do educators spend so much
time focusing on content whencontent memorization has such ashort useful life and when skills aretransferable across positions and last
so much longer?
Using Constructivist TeachingUsing Constructivist Teaching
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Using Constructivist TeachingUsing Constructivist Teaching
Best class is combination of reading (text),video, cases, experiential learning (fieldstudies, service-learning, etc.), group
work, etc.
Critical in the new environmenttohelp our students think analytically
Can no longer use textbook (or CDs) todrive everything we do
Lets look at why this is importantthe Enronexample
Some ThoughtsSome Thoughts
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Some ThoughtsSome Thoughts
Doing whats easiestour trainmonkey or operant conditioningapproach to teaching has led to:
An ethical and public relations nightmare foraccountants and the accounting profession
Rule-based standards that allow firms to
basically do whatever they wantyou cantlegislate everything
Inhibiting their ability to assess risks andthink analytically
T f F dT f F d
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Types of FraudTypes of Fraud
Fraudulent FinancialStatements
Employee Fraud
Vendor Fraud Customer Fraud
Investment Scams
Bankruptcy Frauds Miscellaneous Frauds
The common elementis deceit!
Whats Hot in AccountingWhats Hot in Accounting----77
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What s Hot in AccountingWhat s Hot in Accounting 77Sizzling AreasSizzling Areas
Assurance services--Elder care
Consulting services
Environmental accounting Forensic accounting
Information technology services
International accounting Tax and financial planning
CorporateAccountabilityCorporateAccountability
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p yp ySarbanes Bill
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Whistleblower Protection
Prohibits Disciplining or
Discriminating againstemployees who provideinformation regarding
securities law violations
Attorney Professional Conduct
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Requires Attorneys to ReportMaterial Violations of Securitiesor Breaches of Fiduciary Duty to
the Companys CEO or ChiefLegal Officer or if necessary tothe Board of Directors
y
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New and Increased Felonies + Civil Action
Destruction of of Documents
Longer Periods For Civil Fraud
Increased Criminal Penalties
No Bankruptcy Discharge of Securities Law
Liability
Lower Thresholds To Bar for Unfitness
Auditor
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AuditorIndependence
&
RotationRotation ofAudit/Review Partnersevery 5 years
Prohibits Some Non Audit Services
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Expanded 8 K Disclosures
Accelerated 8 K Reporting 2 Days
8KDisclosures
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Accounting Issues
New Issuer Fees
SECAdopt Principles-based Accounting
System
Unlawful to Fraudulently Influence Auditors
New Rules for Financial Experts on AuditCommittee
New Management Assessment of
Internal Control
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Non-US Companies Not Exempt
New CEO/CFO Apply To Foreign PrivateIssuers
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NASDAQ NYSE
NYSE andNASDAQ
Have Made
Proposals Forthe SEC ToConsider
Enhanced Disclosures
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Enhanced Disclosures
Expenses
Material Off-Balance SheetTransactions
Reconciliation of Pro Form F/S
SEC Review 3 Years
Real Time Disclosuresof Material Changes ToFinancial Condition
Accelerated Due Dates For Periodic
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Accelerated Due Dates For PeriodicReports
MD&A Disclosures of CriticalAccounting Policies
Detailed Quantitative & QualitativeMatters No Boilerplate
Management Transactions
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8 K
Management Transactions
Loans
Security Transactions IncludingPreplanned Purchase/Sale
The SEC Sets New Ground Rules
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The SEC Sets New Ground Ruleson
Selective Disclosure & InsiderTrading
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CEO/CFO
Certification and
DisclosureProcess
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Corporate Code of Ethics
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Enhanced Audit
Committee
Forfeiture ofBonuses, and Stock
Incentives ForRestatements Dueto Misconduct
Majority ofDirectors MustBe Independent
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Dynamic Duo
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Once The Camel Stick Its Head Inthe Tent, We Will Have Problems
The SarbanesThe Sarbanes--Oxley ActOxley Actl did fl did f
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Under a lawthattook effectUnder a lawthattook effectthis month, publiccompaniesthis month, publiccompanies
based in California or doingbased in California or doing
businesstherehaveto givethebusinesstherehaveto givethestateextra layers ofdetail onstateextra layers ofdetail oninsider activity.insider activity.
apparently didnot go farapparently didnot go far
enoughto suit Californiaenoughto suit Californialawmakers.lawmakers.
Key Elements of Public TrustKey Elements of Public Trust
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Spirit of Transparency
Culture ofAccountabilityPeople of Integrity