Dr. Norman Meonske Kent State University

1. The Rise of Corporate Accountability? Dr. Norman Meonske Kent State University Dr. Norman Meonske Kent State University Ohio Council IMA January 30,2003

2. Are WeDead Yet? Accounting Profession

3. Why so many financial statement frauds all of a sudden? "The Perfect Storm" Good economy was masking many problems Moral decay in society Executive incentives Wall Street expectations—rewards for short-term behavior

4. Why so many financial statementfrauds all of a sudden? Nature of accounting rules "The Perfect Storm" • Behavior of CPA firms Greed by investment banks, commercial banks, and investors Bad Lawyer Advice?

5. Why so many financial statement frauds all of a sudden? Failure of Corporate Audit Committees "The Perfect Storm" Board of Directors Failures and Greed Financial Analyst Conflict of Interests and Greed • Education Failures Corporate Accounting Ability Regulation

6. Good economy was masking problems…. With increasingstock prices, profits and wealth for everyone, no one worried about potential problems.

7. Money Makes The World Go Round or Not Go Round

8. Greenspan Prints More Money

10. Don’t Take This Dollar !!! In Norm We Trust

11. Detailed Rules Detailed Complicated Rules With Loop Holes Big Enough To Drive A Truck Through

12. More Rules FASB

13. Nature of Accounting Rules 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

14. Examples are: • SPEs and other types of off- balance sheet financing Revenue recognition approaches, Merger reserves • Pension accounting Other accounting schemes.

15. When the client pushes, without specific rules in every situation, there is no room for the auditors to say, “You can’t do this…because it isn’t GAAP…”

16. DA FASB Example

17. GAAP CRITICISM Fosters Earning Game Does Not Show Value Creation

18. Executive Incentives • Meeting Wall Street’s Expectations • Performance is based on earnings & stock price • Focus is on short-term (quarterly) performance only • Stock prices are tied to meeting Wall Street’s earnings forecasts • Executives have been endowed with hundreds of millions of dollars worth of stock options—far exceeds salary-based compensation (tied to stock price) • Companies are heavily punished for not meeting forecasts

19. 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. Princeton University

20. 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 Jack Welch, Former General Electric Chairman

21. Beat The Numbers

22. How To Play Numbers Game Aggressive Accounting Earnings Management Income Smoothing Fraudulent Financial Reporting Creative Accounting Practices

23. Rewards of The Game Share Price Effect Borrowing Cost Effect Bonus Plan Effect Political Cost Effect

24. How to value a dot.com company: • Take their loss for the year Multiply the result by negative 1 to make it positive • Multiply that number by at least 100 • If stock price is less than the result…Buy, If Not? Buy it anyway

25. Incentives for F.S. Fraud 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?

26. Auditors—the CPAs • Failed to accept responsibility for fraud detection (SEC, Supreme Court, public expects them to detect fraud) If auditors aren’t the watchdogs, then who is? • Became greedy--$500,000 per year per partner compensation wasn’t enough; saw everyone else getting rich • 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 • A few auditors got too close to their clients • Entire industry, especially Arthur Andersen, was • punished for actions of a few

27. 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.

28. 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.

29. Moral Decay • Attendees at the April, 1998 Business Week Forum of Chief Financial Officers revealed: • 67% of CFOs said they had been asked by senior company executives to misrepresent corporate financial results • 12% of CFOs admitted they had actually misrepresented financial results…55% said they had fought off requests to “cook the books” • Honesty studies • 1961: 12% • 1986: 31% • 2002: ???

30. How Much Stanford MBA Worth? • $500,000 dollars • $ 10 Million dollars • $ 100 Million dollars • $ 1 billion dollars

31. 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.

32. Executives at Vetrias, storage management software maker, found that CEO’s claim to have earned an MBA from Stanford Business School was false.

33. Financial Statement Fraud Will Destroy Your Shareholder Value

34. Financial Statement Fraud • Financial statement fraud causes a decrease in market value of stock of approximately 500 to 1,000 times the amount of the fraud. $2 billion drop in stock value $7 million fraud

35. These Are Interesting Times • Number and size of financial statement frauds are increasing • Number and size of frauds against organizations are increasing • Some recent frauds involve several people—as many as 20 or 30 (seems to indicate moral decay) • Many investors have lost confidence in credibility of financial statements and corporate reports • More interest in fraud than ever before—now a course on many college campuses—from 3 or 4 to over 50 college campuses

36. Current Executive Fraud-Related Problems • Misstating Financial Statements: Quest, Enron, Global Crossing, WorldCom, etc. • Executive Loans and Corporate Looting: John Rigas (Adelphia), Dennis Kozlowski (Tyco--$170 million—the $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 Corporate Planes, Executive Apartments with meals, maids, etc.)

37. Current Executive Fraud-Related Problems • Exorbitant Stock Options for Executives

38. Complaint in Fraud Case • Several hundred million in earnings overstatement • Complaint: “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.)”

39. Complaint in Fraud Case • “The participants in the illegal scheme included virtually the entire senior management of (the company), including but not limited to its former chairman and chief executive officer, its former president, two former chief financial officers and various other senior accounting personnel. In total, there were over 20 individuals involved in the earnings overstatement schemes.”

40. 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 Fraud Internationally

41. Largest Bankruptcy Filings(1980 to Present)

42. Recent Financial Statement Frauds • Enron • WorldCom • Adelphia • Global Crossing • Xerox • Qwest • Many others

45. Norm

47. THE BEGINNING 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.

49. 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

50. 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.