Issues o Accounting Fraud

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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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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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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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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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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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

Issues o Accounting Fraud

Documents

Transcript of Issues o Accounting Fraud