Saturday, December 30, 2006

Apple Computer's Stock Options Back Dating Scandal: An Ex-felon's View

The pursuit of criminal conduct in America should not be affected by the ideology and prejudices of those seeking justice and the persons being pursued. The pursuit of Justice must be blind.

Steve Jobs and individuals at Apple Computer must face the same amount of scrutiny as those involved in Enron and other major corporate frauds.

The disclosures in Apple's report are very troubling and require an appropriate investigation by the SEC and US Attorney for possible criminal conduct.

Steve Jobs should welcome such an inquiry if he is in fact not guilty of any misconduct. Mr. Jobs himself must also provide the public with a forthright, reasonable, and transparent explanation without any spin if he is to have any integrity.

I above is a response I wrote to Professor Larry E. Ribstein regarding a commentary he posted on his Ideoblog entitled “The Backdating Zealots’ Apple Problem.” In his commentary he wrote in part:

Just to summarize the emerging blackletter law: It's ok to commit “fraud” (which is what we are repeatedly told backdating is) if (1) you are a media darling who produces fancy products that everybody loves; (2) you can get Al Gore to sign off (I guess this particular truth isn't too inconvenient); and (3) you can get somebody else in your company to do the dirty work.

I am troubled by Steve Jobs picking what I see as a political ally to oversee Apple Computer’s internal investigation. Mr. Jobs has contributed large sums of money to the Democratic Party and its candidates.

I read Apple Computer’s recent 10k report filed with the Securities and Exchange Commission. Apple Computer’s report said that were 6,428 back dated option grants on 42 separate dates over a five year period it concluded that there was no misconduct by current management.

The report said the following about Steve Jobs and certain individuals who had worked at Apple Computer:

Although the investigation found that CEO Steve Jobs was aware or recommended the selection of some favorable grant dates, he did not receive or financially benefit from these grants or appreciate the accounting implications. The Special Committee also found that the investigation had raised serious concerns regarding the actions of two former officers in connection with the accounting, recording and reporting of stock option grants.

The New York Times in an article entitled “Apple Panel on Options Backs Chief” written by John Markoff and Eric Dash on December 29, 2006 wrote the following:


“It appears as if Jobs is playing the role of a monkey: See no evil, hear no evil, speak no evil,” said Lynn E. Turner, a former chief accountant at the Securities and Exchange Commission. “If he truly were fulfilling his role as C.E.O., it is highly questionable as to why he didn’t know about such poor management and oversight of the option granting process.

I am very troubled about this too.

In a previous commentary on this blog entitled “The Art of Spinning: How to Identify Possible White Collar Criminals or at least Unethical and Deceitful People You Should Avoid” I wrote:

When you cannot dispute the underlying facts, accept them as true but rationalize your actions. You are allowed to make mistakes as long as you have no wrongful intent. Being stupid is not a crime.

While I hope this is not that the case with Steve Jobs there are compelling reasons for the Securities and Exchange Commission and the United States Justice Department to pursue a vigorous investigation of the actions of individuals at Apple Computer.

If Steve Jobs and others in current management have done nothing wrong, they should welcome it. They must cooperate in a transparent way with any investigation.

Respectfully,

Sam E. Antar (former Crazy Eddie CFO & ex-felon)

Monday, December 25, 2006

The Art of Spinning: How to Identify Possible White Collar Criminals or at Least Unethical and Deceitful People Who You Should Avoid

White collar-crime is a crime of persuasion and deceit. Since the white-collar criminal uses persuasion and deceit to commit their crimes, it follows that such felons are artful liars.

People often ask me what characteristics I look for in other people that alert me to possible criminal activity or at least unethical and deceitful people.

Not all questionable conduct is illegal. A person can be unethical or deceitful (however they are defined) without committing any illegal acts as defined under the law.

However, most criminals use tools like spinning (see below) in the conduct of their crimes.

The Art of Spinning

Sell people hope. My cousin ‘Crazy Eddie’ Antar taught me that “people live on hope” and their hopes and dreams must be fed through our spin and lies. In any situation, if possible, accentuate the positive.

Make excuses as long as you can. Try to have your excuses based on at least one truthful fact even if the fact is unrelated to your actions and argument.

When you cannot dispute the underlying facts, accept them as true but rationalize your actions. You are allowed to make mistakes as long as you have no wrongful intent. Being stupid is not a crime.

Always say in words you “take responsibility” but try to indirectly shift the blame on other people and factors. You need to portray yourself as a “stand up” person.

When you cannot defend your actions or arguments attack the messenger to detract attention from your questionable actions.

Always show your kindness by doing people favors. You will require the gratitude of such people to come to your aid and defend you.

Build up your stature, integrity, and credibility by publicizing the good deeds you have done in areas unrelated to the subject of scrutiny.

Build a strong base of support. Try to have surrogates and the beneficiaries of your largess stand up for you and defend you.

If you can, appear to take the “high road” and have your surrogates do the “dirty work” for you. After all, you cannot control the actions of your zealots.

When you can no longer spin, shut up. For example, offer no guidance to investors or resign for “personal reasons.” Your surrogates and so-called friends can still speak on your behalf and defend you.

If you are under investigation always say you will “cooperate.” However, use all means necessary legal or otherwise to stifle the investigators. Remember that “people live on hope” and their inclination is to believe you.

When called to testify under oath (if you do not exercise your 5th amendment privilege against self-incrimination) have selective memory about your questionable actions. It is harder to be charged with perjury if you cannot remember what you have done rather than testify and lie about it.

However, before you testify have other friendly witnesses testify before you to defend you. You need to “lock in” their stories first (before they change their minds) so your testimony does not conflict with their testimony and your story will appear to be more truthful.

Try not to have your actions at least appear to rise to the level of criminal conduct or a litigable action. Being stupid or being unethical is not always a crime or a tortious action.

One last rule, to be a most effective spinner always keep your friends close and your enemies closer. The kindness you show your enemies will reduce their propensity to be skeptical of you.

Closing comment

If you see some of the above similarities in people who are in authority such as executives, politicians, and others, you are forewarned to watch out. Before a person can be a white collar criminal, they must be deceitful and be able to follow most of the above rules of spinning.

Written by,

Sam E. Antar (former Crazy Eddie CFO and convicted felon)

I used to tell and write financial fairy tales as a white collar criminal.

Tuesday, December 19, 2006

Why I Do Not Fear Auditors

White collar crime is a crime of persuasion and deceit. Since the white collar criminal uses persuasion and deceit to commit their crimes it follows that such felons are artful liars.

Most accounting professionals are never taught about the nature of white collar crime in college or in their continuing professional education courses after becoming Certified Public Accountants.

The “Challenge of Audit” Blog written by someone called the Thoughtful Auditor recently posted a commentary entitled “Why Sam E. Antar Doesn’t Fear Auditors.”

He (she) wrote in part:


Mr. Antar clearly had no fear of either external or internal auditors while he was committing fraud. He includes some reasons on his site, such as new audit staffers being young and inexperienced, following out of the box and checklist programs, and not receiving adequate supervision from more experienced managers and partners. Although there has been much hype recently about strengthening audits, I tend to think that these conditions still exist in many companies. These criticisms can, in my experience, pertain equally to both internal and external auditors.


Please read the rest of his blog post and my answer posted on his web site here.

Managing Earnings: Playing the Numbers Game

Did you ever wonder why some companies always consistently beat their earnings targets?

Many accounting professionals have written extensively about how companies “manage earnings.” A company can arbitrarily reduce “excessive profits” in good quarters or fiscal years to “save” such earnings and apply them to future leaner accounting periods in order to avoid earnings disappointments.

Jeff Matthews has an interesting commentary in his recent blog post entitled, And Beware CEOs Trying to ‘Hit the Numbers.'"

He wrote in part:

Not only can the focus on hitting a meaningless, and often unsustainable, profit forecast result in stupid, short-term decision making; it can also, as in the case of Tyco, Fannie Mae, Enron, and a list of other companies large and small too lengthy to bother with, result in fraud.

The problem is that management can become so focused and obsessed with hitting earnings targets that certain improper decisions will be made relating to the application of accounting principles to “smooth over” earnings. Ultimately the so called “professional judgment” that management uses in the application of accounting principles can lead to aggressive accounting techniques and even fraud.

The issue here is known as “managing earnings.” Accounting is more of an art than a science because of certain judgments regarding accounting principles by management with the acceptance of its Audit Committee and external auditors. For example, accounting principles relating to sales, leases, depreciation, accounts payable, and inventory all involve some amount of judgment or leeway.

In the Crazy Eddie fraud, one technique we used to manage earnings was by taking excessive arbitrary reserves against inventories in good years and reducing such reserves against inventory in lean years. In fiscal year 1986, we inflated our earnings by about $16 million due to fraudulent means. When Main Hurdman, Crazy Eddie's external auditors, completed their initial computation of the company's earnings, our gross margins were over 40% in the last quarter. Historically, Crazy Eddie’s gross margins were only about 20%. Our excessive earnings inflation should have been a "red flag" for Main Hurdman to investigate further.

Rather than investigate the red flag, Main Hurdman simply agreed to Crazy Eddie booking extra arbitrary “loss reserves” against our inventory valuations. The auditors thought that Crazy Eddie was being “conservative” but in fact they unwittingly helped us reduce our overly excessive fraudulent earnings inflation.

The use of such arbitrary reserves was known as “accountant’s legal liability insurance,” since the rationale was that no company was ever sued for being too conservative or under-reporting earnings. When I asked the auditors about what Crazy Eddie should do with these “excessive” reserves in future years, they replied to me that such excessive reserves was like “money in the bank.” The auditors explained to me that such excessive reserves can be reduced in future lean years to help Crazy Eddie make its future earnings targets.

In the next fiscal year, when Crazy Eddie started losing money and no amount of fraud could turn such losses into profits, we reduced our excessive arbitrary reserves that we had set up in the prior year, with our auditors’ collusion.

While the external auditors were not involved in falsifying inventory, they were unwitting accomplices to our fraud, since they helped us “manage earnings” through the use of arbitrary inventory reserves.

In many of my conversations with Wall Street analysts, underwriters, and other CFO’s, I found out that the practice of “managing earnings” was prevalent and an accepted business norm.

Wall Street does not like surprises and the extra swing that management gets from applying so called judgment to accounting principles allows them to constantly beat their earnings targets. In good years, certain companies will save “unneeded excess earnings” through arbitrary excessive reserves, to save such earnings for the lean quarters or years when they do not make their earnings targets.

Written by,

Sam E. Antar

PS: I am not making this up.

Friday, December 15, 2006

Cooperation: Andrew Fastow vs. Sam E. Antar

Andrew Fastow the former Chief Financial Officer of Enron and now a convicted felon has signed a “cooperation” agreement with the class action plaintiff law firms involved in recovering losses on behalf of many victims of the Enron fraud.


According a D & O Diary blog article entitled "Enron, Halliburton, and the Milberg Weiss Criminal Investigation" written by Kevin M. LaCroix:

“In return, Fastow received “the formal support of the Enron investors in a plea for leniency (a factor the Judge explicitly noted).” Fastow was also dismissed as a defendant from the civil suit and “even got the plaintiffs’ lawyers to pay his legal fees for his deposition.” As a result of the plea for leniency, the 10-year sentence to which Fastow agreed when he first entered his guilty plea was reduced to 6 years.”


In the Crazy Eddie fraud investigation I also “cooperated” with the government, civil plaintiff’s attorneys, and victims of my crimes. As a result of such “cooperation” they wrote letters to my sentencing Judge noting my “extensive cooperation” which probably kept me out of prison and left me without any civil judgments.


In the Wall Street Journal Law Blog I commented on an article entitled “Are Sentences for These Men Too Long?” written by Peter Lattman about my own cooperation and sentencing:

I have made no secret of the fact (as disclosed on my web site and public appearances) that my reason for “cooperating” with the government and civil plaintiffs was out of self interested fear of a very long prison sentence.


The government had me “cornered” and other family members more culpable than me had set me up to take the fall. Had I not been caught and learned from the consequences of my criminal actions I would still probably be a criminal today.


However, when I did “cooperate” for whatever reason, I did so without the protection of any plea bargain agreement and met thousands of times with investigators without my attorney present. I cooperated (yes of out self interest) and protected myself later with a plea agreement (unlike most felons today).


After about four years of cooperation (which included thousands of meetings without my attorney present) I first signed a plea agreement for two felonies with the US government. A little later they wanted three felony counts after I had agreed to two felony counts and I obliged them by pleading guilty to three felonies.


My “cooperation” was the cornerstone of the Crazy Eddie criminal and civil investigation which resulted in the victims recovering almost all monies made by the Antar family on the Crazy Eddie stock and having an unprecedented percentage recovery by victims of the fraud.


At sentencing I did not bombard the Judge with letters from everyone who I did a good deed for, family members, etc. There were only about 5 letters that went to the Judge – The US Attorney, the SEC, and the balance from attorneys representing all victims of the crimes. They all took note of the value of my “cooperation.”


At sentencing I told the Judge “For most of my adult life I was involved in a massive fraud. I’m embarrassed to…say that I always knew what I did was wrong” and I was ready to fully accept the consequences of my actions. The US Attorney recommended a downward departure sentence of about 2 years from my sentencing guideline exposure of about 4 to 5 years.


The Judge (a “law and order” Ronald Reagan appointee) sentenced me to 6 months house arrest, 1,200 hours of community service, three years probation, and fines.


While you may disagree with this “law and order” Republican appointed Judge’s decision regarding my admittedly light sentence the fact is that he took into account the truthfulness of my testimony, the fact that I made no excuses, the fact the I used no handler’s (attorneys) in making myself fully accessible to both criminal and civil plaintiff investigators and most of all the fact that I was willing to risk everything (by having no legal protection for 4 years) in helping the government and civil plaintiffs obtain justice (yes, for selfish reasons).


I have always disclosed my feeling that my sentencing was lenient and never said otherwise. I have learned that it is better to face the mercy of your victims and a sentencing Judge rather than face their anger.”


The difference between my self interested cooperation and Mr. Fastow’s is that I took the shot of helping the government, various civil plaintiffs attorneys and victims without the benefit of any legal protection in the hope that I would face their mercy rather than anger.


It seems that Mr. Fastow would have been wiser to cooperate with them the same way I did instead of covering himself first. He may have spent less time in prison.


The civil plaintiff’s attorneys could learn a lesson here too. You would not face the criticism leveled at you had you treated Andrew Fastow like me.

Sunday, December 10, 2006

Hiding Your Dirty Laundry in the Footnotes: Anatomy of the Crazy Eddie Accounts Payable Fraud

I once listened to a presentation about white collar crime by reformed criminal now Pastor, author, and crime fighter Barry Minkow (ZZZZ Best fraud) at the Value Investing Congress in New York City.

Barry Minkow explained to the audience of large investors something called the “iceberg” analysis. According to Barry, an iceberg is only 10% visible and the rest of it lies beneath the surface. It is often difficult to detect fraud and misrepresentation just by looking at financial statements.

Financial statements are often accompanied by footnotes which are seldom read and more often not thoroughly analyzed by investors. A great blog footnoted.org written by Michelle Leader sorts through the footnotes of companies and provides excellent analysis.

One of the many frauds committed by me at Crazy Eddie involved manipulating just two words in our footnotes.

Prior to 1987, Crazy Eddie accounting policy for purchase discounts and allowances was:

Purchase discounts and trade allowances are recognized when received

This accounting policy meant that even if Crazy Eddie had “earned” a discount it could not be recognized as income until a credit was received from the vendor.

In fiscal year 1987, I changed Crazy Eddie’s accounting policy (as reflected in the footnotes) to:

Purchase discounts and trade allowances are recognized when earned

Now, in theory, Crazy Eddie could recognize a discount as income when it is earned (for example when we reached the manufacturer’s benchmark of buying 10,000 units to qualify for a volume rebate) and not have to wait for a credit from the vendor. I could simply write a debit memo (an offset to what I owed the vendor) to recognize the discount and increase our reported profits.

A change of accounting policy would normally give rise to a separate disclosure about its effect on earnings. However, in the Crazy Eddie fraud we made no such disclosure and the auditors made no relevant computations despite change in accounting principle. The auditors simply ignored the effects of the change in accounting for discounts.

By now being able to recognize discounts "when earned” instead of having to wait for credits to be received from vendors, I had the opportunity to add $20 million on phony debit memos (phony discounts and trade allowances) charged to vendors.

Crazy Eddie’s accounts payable was reduced from about $70 million to $50 million through the use of phony debit memos that was facilitated by our change in accounting policies for purchase discounts and trade allowances by changing just two words in our footnotes.

You may ask: How did we do it and how could the auditors allow this to happen?

The staff auditor primarily responsible for the accounts payable part of the audit had no retail accounts payable audit experience and only six months experience in auditing. He did not know what a debit memo was until he came to the Crazy Eddie audit.

We engaged in a scheme of obstruction by distraction. Most staff accountants feel that audits are boring and they really are. As soon as the young relatively inexperienced staff members walked into our premises, my staff was instructed to be overly friendly so that they could be distracted from their work. We would constantly take the staff auditors out for long coffee breaks and lunches and engage in friendly conversations about mutual topics of interest unrelated to the audit in an effort to distract them from their work.

About two weeks before the audit was due to be completed and the accountants should have completed about 85% of the their work, they would have only about 25% of their work done. During the remaining two weeks they would scramble to finish the audit on time.

When people “cram” or rush they make extra mistakes and tend to skimp on their work. In addition, the auditors could not blame the overly friendly Crazy Eddie staff for obstructing them. Therefore, in a mad scramble to “cover their asses” they covered ours. In the process they left out some very important audit procedures.

In fiscal year 1987, the staff auditor assigned to analyze accounts payable did not begin his work until the very day his firm had signed off on Crazy Eddie’s “clean” audit opinion.

The actual audit of the accounts payable was concluded weeks after the auditors signed off on our financial statements and gave our Board of Directors their approval for its release.

For fiscal year 1987, the auditors did not compute how many debit memos offseted our gross accounts payable and they never generated an aging schedule of accounts payable. (Note: In the previous fiscal year audit the auditors generated an accounts payable aging schedule.) An aging schedule would have listed for how long we owed vendors amounts listed in accounts payable at year end and likewise how long such debit memos were not applied against amounts owed to vendors.

The computation of the total debit memos was especially important in determining the effects of the change in accounting for discounts and allowances. Such a computation combined with an accounts payable aging schedule would have determined that excessively large amounts of debit memos were never actually used to offset amounts owed to vendors. This procedure would have alerted the auditors to the excessive amounts of phony debit memos and their lack of validity.

The auditors only received three accounts payable balance confirmations from our vendors and suppliers. One vendor confirmation received by the auditors had over $4 million in phony debit memos. They simply traced those debit memos to our accounts payable records which listed the phony debit memos. They never contacted the vendor after receiving the confirmation about reconciling items.

There are many lessons to be learned from the Crazy Eddie accounts payable fraud.

People (even sophisticated investors) do not read footnotes. Had they read the footnotes carefully perhaps the proper critical questions would have been asked. All too often audits are over-used as training grounds for relatively inexperienced staff accountants who are not adequately supervised.

The audit was poorly planned, executed, and supervised. The auditors lost their requisite professional skepticism and objectivity by permitting Crazy Eddie staff to distract them from their work by “bonding” with them. They did not follow basic audit procedures and permitted deadlines to guide to quality of their work.

Crazy Eddie had weak internal controls over the issuance of debit memos. There was no documentation from external sources supporting any of the phony discounts. Sarbanes-Oxley would have required the auditors to evaluate our internal controls.

Finally, as Joseph T. Wells (retired founder and Chairman of the Association of Certified Fraud Examiners) who wrote about this same fraud in his award winning article “So That’s Why They Call it a Pyramid Scheme” published in the Journal of Accountancy in October 2000:

....Were the auditors stupid? No, just too trusting. After all, no one wants to think the client is a crook. But it happens too often. That's why the profession requires the auditor to be skeptical.

Written by:

Sam E. Antar (former Crazy Eddie CFO & convicted felon)

Monday, December 04, 2006

In Class Action Securities Litigation Sometimes I Wonder Who are the Clients

Recently Floyd Norris in his blog Notions of High and Low Finance and Peter Lattman in the Wall Street Journal Law Blog posted articles about William S. Lerach (formerly a partner of the indicted Milberg Weiss law firm).


In his post entitled “Making Lerach Pay” Norris wrote:

“William S. Lerach, the class-action securities lawyer most hated in Silicon Valley, and his law firm have been ordered by a federal judge in Houston to pay some of the legal costs incurred by Alliance Capital after Mr. Lerach sued the company in the Enron case. The judge says that Mr. Lerach pursed the case after it became clear it had no merit.”


Mr. Norris asked the following question:

“Would the deterrent have been greater if the penalty had been assessed against the lead plaintiff in this class action, the regents of the University of California, rather than against Mr. Lerach’s law firm? Might such a ruling make institutional investors less willing to serve as lead plaintiffs in class action suits?”


In his post entitled “Judge: Lerach Should Pay Attorney’s Fees in Enron Litigation” Peter Lattman wrote:

“Securities litigators are also surprised by her suggestion in the opinion that Lerach’s law firm, the lead counsel in the case, pay the legal fees and costs of Alliance (now known as AllianceBernstein), rather than the plaintiffs themselves.”


I wrote the following comment in both of their Blogs:


I have learned from my training as a CPA to look at “substance over form.” In “form” many of law firms in the “class action” bar represent shareholders who are in theory their clients.


Unfortunately, in “substance” when we examine the pattern of behavior of certain law firms it appears that they have given up the ideals of the legal profession and now act as self serving businesses that represent not their client’s interest but their own interests.


Since the passage of the Private Securities Litigation Reform Act of 1995 was passed in law, large institutional investors (such as large public pension funds) have more power in the selection of the lead plaintiff’s counsel in class action securities litigation.


An unintended consequence the law has created is at least in appearance and possibly in practice is a “pay to play” situation.


Certain class action law firms funnel political contributions to politicians who serve as fiduciaries or politicians who appoint various fiduciaries to the large public pension plans who often exert considerable influence in the selection of lead counsel.


As a result, other law firms who are “less politically connected” that are vying to be appointed lead counsel are at a disadvantage due to the political contributions of competing law firms. These law firms who do not make such political contributions may be able to represent shareholders interests more effectively and economically.


There has been an increasing concentration of power in a few selected class action plaintiff law firms since this legislation has been enacted. Many such firms are those that seem to use their political clout.


We have seen the recent indictment of the Milberg Weiss law firm and more indictments may be coming. It is alleged that certain individuals at Milberg Weiss bribed people to be lead plaintiffs in shareholder litigation so it would increase the law firm’s chances of being selected lead counsel.


In many of these class action law suits the law firms make out much better economically than the supposed “clients” they represent – unless of course such clients have received bribes or are the beneficiaries of political contributions via “pay to play.”


Therefore, I can understand the Judge’s decision to make Mr. Lerach’s law firm pay some legal costs.


Mr. Lerach was a partner in the Milberg law firm and is no stranger to actions that create at least the appearance of “pay to play.”


Certain law firms of the class action plaintiff’s bar by bringing unwarranted law suits, possibly bribing potential “clients”, engaging in possible “pay to play”, and charging excessive legal fees are violating the same principles of transparency and accountability they claim to defend.


By such actions they give ammunition to those who seek to reduce accountability and responsibility of corporate executives who violate the integrity of our capitalist free market economic system.


Respectfully,


Sam E. Antar

PS:


I was rightfully sued by Milberg Weiss in the Crazy Eddie class action litigation.


If the allegations against the law firm and certain defendants in the indictment are true it would be particularly distressing for me that members of the very same firm that prosecuted me in the name of rooting out criminality have possibly succumbed to the same level of my former immorality.


Sunday, December 03, 2006

D & O Insurers Can Help in Corporate Governance

The D & O Diary features a commentary Kevin LaCroix entitled “Why Aren’t D & O Insurers Better Corporate Governance Monitors?”

Insurance carriers can play a major role (and they have an economic incentive to do it) in pushing companies to have better corporate governance and financial transparency.

I strongly suggest you read Mr. Lacroix’s blog about his other ideas.

Saturday, December 02, 2006

When Regulatory Relief Really Means Relaxing Standards of Transparency and Integrity

The Committee on Capital Markets Regulation released its interim report this week. According an article in USA Today entitled Group: Sarbanes-Oxley needs to loosen up” written by Greg Farrell and published on November 29, 2006:


“…the study was funded by the Starr Foundation, a group headed by former AIG chairman Maurice "Hank" Greenberg, and a philanthropist who didn't want to be named.”


Floyd Norris commenting in his New York Times blog “Notions on High and Low Finance” wrote in a post entitled “Who Paid for the Anti-Regulation Report?”



“The report of the Committee on Capital Markets Regulation…has a distinct anti-regulation tinge, arguing that excessive regulation is hurting the United States competitively.”


I wrote the following comment in Mr. Norris’s blog:



Perhaps a more appropriate name for the “Committee on Capital Markets Regulation” would be the “Political Action Committee on Reduction of Standards for the Integrity of our Capital Markets.”



Members of this Committee under the guise of seeking regulatory relief from burdensome rules are seeking to relax standards of transparency and integrity which are vital to our financial markets. Need I remind you the about the disastrous results of loosening educational standards in America a generation ago?



If this Committee whose purpose is to help capitalism by promoting transparency and integrity in our capital markets wishes to lift itself of the “Political Action Committee” designation, it should start by making full disclosure of its funding sources at the very least.



Many of the solutions offered in the report are downright defeatist. Rather than seeking liability protection for external auditors and outside directors, the report does not address the basic issues that cause these litigations to occur – auditor and outside director negligence.



The Committee recommends “risk based approach” to regulation and audits. However, we have an education system that does not adequately prepare our Certified Public Accountants to be sufficiently judgment oriented in their professional responsibilities. That is why we have an audit process that is nothing more that “fill in the blanks” and “check the boxes.”



Most CPAs will never take a single specific college level course in fraud, internal controls, securities law, and many other crucial subjects prior to graduation. After graduation and obtaining a CPA license the American Institute of Certified Public Accountants only “recommends” but does not require that 10% of annual continuing education courses be taken in the subject of fraud – hardly enough.



Audits are over used as training grounds for relatively inexperienced, under skilled, and under trained staffers who are not adequately supervised by more knowledgeable senior accountants.



We have outside directors who can still have stock options and own stock in the company of the Board’s they serve on.



Many of these Board Members have very nice resumes. However, they have no experience in the company’s industries whose Board they serve on. They have no relevant experience and education to fulfill their role of effective Board Members. In fact, their sole reason for being appointed as Board Members with their nice looking but irrelevant resumes is purely “window dressing.”



The external auditors are supposed to be monitored by the Audit Committee of the Board of Directors. In practice such Audit Committees are no better prepared (if not worse) to handle their responsibilities than the external auditors they oversee.



Many Audit Committee members receive compensation in stock options or own company stock of the Board they serve on which provides a disincentive to effective independent oversight and can affect their objectivity and professional skepticism.



In addition, many members of Audit Committees have no formal accounting, auditing, internal control, and fraud education or backgrounds. Their requisite education, skills, training, and experience required to fulfill their responsibilities are lacking.



The convergence of “ill trained” auditors and “window dressed” Audit Committees creates ineffective oversight of the financial integrity of companies and provides a “perfect storm” for more massive frauds to come.



My message to the Committee on Capital Markets Regulation and the readers here is that transparency and financial integrity while difficult is necessary and achievable.



Companies obtaining capital from public markets have a fiduciary duty not only to their shareholders but to the integrity of our great capitalist free market economic system to invest resources in good internal controls and oversight to provide comfort as to the transparency and integrity of their financial reports.



The accounting profession talks about an “expectations gap” regarding the public perception of what audits are supposed to achieve. Most problems arising today involve material fraud which has nothing to do with such an excuse.



I challenge the accounting profession to self evaluate and improve itself and move away from the defeatist attitude of looking to cut your losses. With educational reforms you can capably perform your tasks and reduce your risks.


The SEC should revise corporate governance rules regarding the qualifications of Board Members (especially Audit Committee Members) and not permit such members to own stock, receive stock options, and receive earnings based compensation in the company of the Board they serve on.