"a fish, a barrel, and a smoking gun"
for 18 July 2000. Updated every WEEKDAY.

















The Hardship of Accounting



You call it a religion. We call it a cult. Everybody else calls it a market. Despite abundant evidence that trading the notional value of companies through a stock exchange requires Branch Davidian-worthy leaps of faith, the sheer number of no-farting-in-the-pews regulations makes it all seem to be governed by human, rather than divine, law. There may be no more regulated, or at least more picked-over, human activity than the stock market. As in any highly controlled environment, the acronyms are supposed to suggest the vigorous intricacy of the machine: Here's the SEC fussing over FASB's shaping of GAAP, and monitoring IOSCO's review of IASC's work on the same question at the international level, while the NYSE and the NASD form a blue ribbon accounting standards committee formed of "leading CFOs who are members of the FEI." And then, of course, down at the place where tangible value is supposedly measured, an elaborately devised structure of putatively independent auditors reviews the work of corporate financial officers who are sworn to professional ethics and watched over by audit committees designated to safeguard shareholder value. All of which is finally intended to guarantee that some Nicoderm-shocked Paxil user frantically clicking the "execute trade" button is buying something like what he thinks he's buying.

And so, when a whistleblower finally pointed out that a now-defunct corporation once known as Comp-U-Card International (CUC) — the body of which, following a merger, now forms part of the extremely large Cendant Corporation — had engaged in $19 billion in accounting fraud over the course of a decade, someone had to be held responsible for letting the process down. Government prosecutors settled on the company's top accountants; reporters decided to wonder about the auditors who had repeatedly signed off on the extremely fictional ledgers. And this is where an executive of the auditing firm, Ernst & Young, explains that you can't actually expect the whole structure of checks and balances to, you know, really work: "That suggestion is offensive," the firm's general counsel helpfully explained to the New York Times recently. "The CUC people were so determined to fool the auditors that they could fool any audit firm or any team of auditors."



Which is too bad, because the people who regulate the buying and selling of publicly held companies in the United States appear to be convinced that pretty nearly everyone is determined to fool the auditors. And it's something that's been on their minds for quite a while: A few years ago, for example, Securities and Exchange Commission Chairman Arthur Levitt decried the practice of so-called earnings management as "a game among market participants... that runs counter to the very principles behind our market's strength and success," then genially explained that he was about to "explore five of the more common accounting gimmicks we've been seeing."

Levitt, and the people who work for him, have made a point of describing fraudulent corporate accounting, and the nudge-and-a-wink auditing that accompanies it, as the product of a cultural failure. Seeking a solution, however, the people at the SEC — and everyone else with a stake in the question — have maintained a firm faith in the fallacy of checks and balances. How do you stop companies from lying to their shareholders? The laws that underlie all of this were passed back in the early 1930s. Now it's just a matter of tightening up the procedure a tiny bit more. That blue ribbon NYSE/NASD committee came up with some ideas last year for doing just that: requiring audit committees to be "comprised of (sic) independent board members who have a sufficient level of financial knowledge," for example, and holding "ongoing robust discussions between the audit committee and auditors regarding the auditor's independence." Late last month, the SEC even proposed new rules that would prohibit auditing firms from doing other work for the companies they supposedly keep an eye on. "This is the first time there has ever been a rule proposal on the scope of services these firms provide," says the SEC's chief accountant. "People have wondered whether that growing scope related to some of the major audit failures we have seen." In other news, people have been wondering if the cops have been taking it easier on the crooks since they bought a house together.



In California, meanwhile, that question has pretty much been answered. Republican hotshot Chuck Quackenbush — who according to the script was supposed to become governor eventually — was first elected as the state's insurance commissioner in 1994, the year of the Northridge earthquake. Quackenbush was only the second person elected to the office, which was made an elective rather than appointed position in 1991 in order to guarantee more publically accountable regulation of the insurance industry. And the voters got what they asked for, more or less: Quackenbush's staff reviewed thousands of claims from the '94 earthquake, and found that some of the state's biggest insurers had, as the Los Angeles Times put it, "demonstrated a pattern of lowballing, delaying or misleading consumers." They threatened to pile literally billions of dollars worth of fines on the industry. Unless, uh — well, come a little closer, so we can whisper it.

And so a pair of nonprofit agencies, set up by Quackenbush to help consumers and orphans and what have you, began raking in tax deductible charity from a bunch of big insurers; one of the funds eventually received more than $12 million. And the money went to some very important charitable causes — television commercials that let voters know what a great guy Chuck Quackenbush was, for example, and some political polling, and a football camp attended by the insurance commissioner's sons. When his own staff began leaking disturbing information to Quackenbush's old colleagues in the state legislature, the creative accountant in the insurance commissioner's office went Hillary: The vast left-wing conspiracy, he explained in a letter to 15,000 registered Republicans (which began with the memorable line, "Greetings from my garrison in Sacramento."), was out to get him; he had been "tried, sentenced and crucified all at hands of the media." Quackenbush walked out on a legislative hearing, and some of his top aides nervously took the fifth, but a few brave souls actually provided information. One senior insurance commission lawyer, Robert Hagedorn, told legislators that Quackenbush had personally ordered him to collect $4 million in settlements with insurance companies so there'd be money in the kitty for politically helpful television commercials. Ranting like a martyred saint right up to the very end, Quackenbush eventually embraced reality and handed over a terse resignation letter.


The people who run Cendant now say that they hope to recover damages from the former CUC executives who perpetrated all that accounting fraud, but no one really expects them to earn $19 billion working in the license plate shop. California's new interim insurance commissioner promises to restore trust in his office, but it's hard to imagine how that might help the lowballed, misled victims of the Northridge earthquake. And everybody in or around both situations swears that they're going to tighten up the rules to make sure it never happens again.

In both instances, systemic failures were halted by individual action. Various systems of checks and balances ran straight along the usual track, missing everything, until someone who worked in the office where the fraud was happening snuck some photocopied documents out into the sunlight. And that is how, when all the new rules are in place, future fraud is going to be exposed. We can keep reforming the system, but expecting it to work any better is like hoping the Pope might agree to term limitations.

courtesy of Ambrose Beers
picturesTerry Colon

Ambrose Beers