Friday, August 27, 2010

FEI Introduces New 'Associate' Member Category

Yesterday, Financial Executives International issued a press release announcing a new 'Associate Member' category:

The Board of Directors of Financial Executives International (FEI), the association of choice for CFOs and other senior-level finance executives, today approved the addition of a new class to its membership structure through the addition of the 'Associate' category.

This new category, which will take effect immediately, was established to enable talented, motivated financial professionals to have ongoing opportunities for personal and professional growth as their careers advance. The result of this addition will be a larger, more influential association in the finance and accounting community....

... Associate members will enjoy many of the rights, privileges and services of the existing FEI membership. All applicants for membership for this category must possess a minimum of seven years work experience in the finance profession and a minimum four year University/College Bachelors degree, which is subject to verification.

All interested applicants can obtain a full description of criteria requirements and download an application at .

Thursday, August 26, 2010

When Litigation Kills the Accounting Profession-Don't Say You Weren't Warned!-GUEST POST by Jim Peterson

NOTE: While I am on vacation, I invited some guest posts from popular bloggers. Following is a guest post from Jim Peterson, a former senior in-house lawyer and partner with a then-Big Four accounting firm, and author of the blog Re:Balance. He formerly wrote a column for the International Herald Tribune and has taught MBA-level courses in risk management at business schools in the U.S. and in Paris. Jim's guest post follows.

With the devilish details of the Dodd-Frank Act now to be worked out and many special interests weighing in, legislative activity in the American financial sector returns to a standstill – probably until after the elections of November 2012.

So what would bring to the forefront a topic that to most is sleep-inducing, although it keeps some few from sleep: namely, the very viability of the large accounting firms and their fragile franchise to audit the world’s global companies?

Nothing less, presumably, than an existential shock to the stability of one of the Big Four tetrapoly – an unresolvable criminal investigation or a “bad case” outcome in one of their nightmare civil cases.

The firms are on a fortunate streak: the credit-crisis cases resolved so far are within their pain tolerance – namely, KPMG’s Countrywide settlement of $ 24 million, and its $ 44.74 million shareholder settlement and reported trustee resolution in New Century (on which, don’t miss Francine McKenna last week). And the Seidman firm has at least a temporary reprieve from its adverse $ 521 million verdict in the Bankest litigation in Miami (here).

Sadly it is not strategy, but wishfulness, to think that a further shock won’t or can’t happen, just because it hasn’t – at least since Arthur Andersen’s post-Enron disintegration in 2002. This “induction flaw” was illuminated by Nassim Nicholas Taleb in "The Black Swan" -- widely bought, and equally widely misunderstood or simply ignored.

Just as it would be naïve not to be actively concerned for another terrorist attack on American soil, or the next financial bubble already in gestation, so too the prospect of a disruptive blow to the audit market is too real to ignore. Recent bullets may have missed KPMG, but among the many loaded chambers in the game of Russian roulette are Washington Mutual (Deloitte), Glitnir Bank (PwC) and Lehman - particularly Lehman's Repo 105 transaction (Ernst & Young).

The 500 pound gorilla lurking in the room -- where lively debate really should be on-going -- is that the accounting firms’ organizations and capital structure are incapable of withstanding financial outflows greater than about $ 1 to $ 2 billion – a small fraction of the damages claimed in the largest of their big cases.

If this topic is not faced explicitly and head-on – both by the profession’s critics whose howling takes no account of its limited resources, and by its advocates whose potential “solutions” have lacked feasibility and credibility (here) – then a discussion not only goes nowhere, it doesn’t even start.

[Notes: (Jim Peterson: Under then-US Secretary Henry Paulsen, the U.S. Treasury formed an advisory committee called the Advisory Committee on the Auditing Profession (ACAP), of which I was a vigorous critic – e.g., here, here and here -- for its squandering a unique opportunity for real leadership.) (Editor (EO): See the FEI blog's most recent post relating to implementation of ACAP recommendations here which links to earlier posts on that ACAP.]

I’ve unpacked these numbers before – here and here. The chance to dust them off was reason enough to take up Edith Orenstein’s kind invitation to offer a guest post. She will join me, I am sure, in welcoming your feedback – either on my post directly on the FEI blog, or or on my own Main page at my blog, Re:Balance

Wednesday, August 25, 2010

SEC's Approves 3% Solution For Proxy Access

Earlier today, consistent with the provisions of the Dodd-Frank Act, the SEC approved what I'll refer to as the "three percent" solution for the contentious issue of proxy access. As summarized in detail by James Hyatt of Business Ethics Magazine:

Under the new rule approved by the Commission, shareholders seeking access to corporate proxy materials would:

--have to own at least 3% of the total voting power entitled to vote at the meeting.
--be able to aggregate holdings to meet the 3% requirement.
--be required to have held their shares for at least three years.
--not be able to use the new rule "if they are holding the securities for the purpose of changing control of the company."
--be able to include one nominee or a number up to 25% of the board, whichever is greater. (If a board had three members, shareholders could nominate one; if a board had eight members, up to two nominees could be proposed)....

The SEC said "'smaller reporting companies" would be subject to the rule only after a three-year phase-in period. Commission staff said the three-year delay would enable smaller companies to see how the rule works at larger companies and how it would affect them. It would also let the commission determine whether changes in the rule might be required, the staffers said....

The new rule -- called Rule 14a-11 -- requires shareholders to submit nominees no later than 120 days before the anniversary date of the mailing of the prior year proxy statement. Thus, if the rule becomes effective on Nov. 1, 2010, it would be available at companies that mailed their last annual meeting proxy statement no earlier than March 1, 2010....

As had been widely expected, the SEC acted on a 3-2 vote to adopt the new procedures, with Republican commissioners Troy Paredes and Kathleen Casey voting no.
Here is a link to SEC's press release issued after the open meeting, which includes a link to the 451-page final rule. As noted in the press release, the rule becomes effective 60 days after it is published in the Federal Register.

Tuesday, August 24, 2010

FASB Chairman Bob Herz Retiring Effective Oct. 1; FASB Board To Return To Seven Members

It's rare that I actually feel saddened by a post but I am a bit shocked and saddened [once again, see disclaimer on the right side of this blog] to see that FASB Chairman Robert Herz has announced he is taking early retirement as of Oct. 1, 2010. FASB Board Member Leslie Seidman will fill the role of Acting Chair until a replacement board member and a chair among those board members is chosen. Herz' term was originally to last until June 30, 2012.

FAF To Return FASB Board To Seven Members From Five
Separately, the Financial Accounting Foundation (which oversees FASB) also announced that the size of the FASB board will return to seven members, thus reversing the decision made by the FAF a few years ago in which they decreased the size of the FASB board to five members. I personally [please note again the disclaimer on the right side of this blog] had discomfort with the decision to reduce the size of the board and the way it was handled, as noted in my June 25, 2009 blog post "FASB and Due Process." Since the majority of comment letters filed when the proposed reduction in size of the board were against the reduction, I personally anticipate most of FASB's constituents will be pleased with this decision to bring the board back to seven members. FEI's Committee on Corporate Reporting and Committee on Private Company Standards were among those who filed comment letters in Feb. 2008 opposing the then-proposed reduction in size of the FASB board.

Here is a statement issued by SEC Chairman Mary Schapiro in response to FASB's announcement.

My Two Cents
I remind you again of the disclaimer on the right side of this blog...I'm sure speculation will abound as to Herz' decision to retire early. In my view, e.g. through listening to webcasts, particularly of the joint IASB-FASB Financial Crisis Advisory Group that met a couple of years ago, and the goings-on relating to Congressional hearings on fair value, and threats to FASB's independence during drafting of the Dodd-Frank Financial Reform Bill, I felt that Herz (and the boards in general) were under a great deal of pressure, as noted here, and that Herz may have found some of his own views evolving over time on the issue of fair value, perhaps from further consideration, perhaps from wider outreach and perhaps a wider definition of 'investors,' as noted here and here.

I choose at this time not to over-speculate, but simply to wish Mr. Herz, Ms. Seidman and the entire board well during this transition. I truly believe that being a FASB board member must be one of the most difficult jobs in the world, including because, to a large extent, the world rests on their shoulders, and I give all the board and staff members credit for dedicating themselves to that.

SEC To Vote On Proxy Access Wed. Aug. 25

As noted in SEC's recent Sunshine Act Notice the Commission will meet tomorrow (Wed. Aug. 25) to:
consider whether to adopt changes to the federal proxy and other rules to facilitate director nominations by shareholders.
In plain English (or perhaps slang), the issue of shareholder nomination of directors has been referred to as 'proxy access.'

Props to Broc Romanek of blog part of the dynasty) who reported on this previously here, and whose award-winning blog follows SEC developments closely.

In that same post, Romanek noted that FASB extended the comment period for its proposal on disclosure of loss contingencies - including litigation (which we previously noted here), and he posted a link to a WSJ editorial by the U.S. Chamber of Commerce and the Chamber's comment letter filed on Aug. 11 on FASB's proposal.

On this subject, a comment letter was filed by one of FEI's Committees last week (see the letter filed by FEI's Committee on Private Company Standards), and an additional letter from another committee(s) is expected to be filed later this week; we will update this post to add a link to the additional committee(s) letter after it is filed.

Watch the live webcast of the SEC open meeting at which the Commissioners discuss and vote on proxy access, beginning at 10am on Aug. 25; here is the agenda which goes into a bit more detail than the Sunshine Act Notice. The SEC generally issues press releases on major rulemaking items late in the day or next-day following a Commission vote, watch for a press release here.

Friday, August 20, 2010

The Problem With a Non-CPA CFO - GUEST POST by Francine McKenna

NOTE: While I am on vacation, I invited some guest posts from popular bloggers. Following is our second guest post from Francine McKenna, managing editor of Re:The Auditors. She is also a popular speaker, and will be on a panel at the New York County Lawyer's Association on Sept. 15. Her guest blog post follows.

There’s been quite a bit of press about American Apparel’s financial troubles. It’s now three weeks since the company announced that its auditor, Deloitte, had resigned. (See also the company's Form 8-K and the auditor's response.) Shares plunged almost 25% on that news.

It’s not often that we see the details behind a high profile auditor resignation. It’s even more unusual to see that auditor resignation investigated by the U.S. Attorney's Office. Further, if a company goes bankrupt, we may learn more about how the auditor relationship deteriorated via a bankruptcy examiner’s report.

New Century Financial Corp. creditors have asked a federal judge for permission to investigate KPMG LLP's relationship with the bankrupt subprime mortgage lender…New Century's official committee of unsecured creditors said it wants to obtain documents from KPMG, and question current and former officers concerning its accounting, auditing and other services for New Century. KPMG resigned as auditor on April 27, 25 days after New Century filed for Chapter 11 bankruptcy protection from creditors.
Part of the problem with American Apparel may be its thirty-one year old CFO Adrian Kowalewski. It’s beyond my ken how a listed, public company with a history of accounting issues can get away with naming an investment banker with no CPA or even a hint of hands-on accounting experience to CFO.

“In his new role as Chief Financial Officer, Mr. Kowalewski will also have oversight over financial management, accounting, and financial reporting, including Sarbanes-Oxley compliance… Mr. Kowalewski began his career in investment banking at CIBC World Markets in mergers & acquisitions. He also worked at Houlihan Lokey Howard & Zukin and Lazard Frères & Co., both investment banking firms, where he was involved in mergers & acquisitions and financial restructurings. Mr. Kowalewski received a bachelor’s degree with honors in economics from Harvard University, and an MBA from the University of Chicago Graduate School of Business.”
Do you remember the last time we had a high-profile non-CPA CFO trying to sort out serious accounting issues?

Does the name Erin Callan mean anything to you?

In retrospect, it is easy to see the error of her ways for taking the job and of Lehman’s management for appointing her. What public company, of the size and stature of Lehman, in trouble already, can afford to have a CFO who is not an accountant? Have we not seen what happens when a CFO has no interest or aptitude for GAAP? A seasoned CPA CFO – not Mr. Kowalewski - would have known that an auditor resignation over “controls” could lead to lots of questions. Auditor resignations also eventually lead to lots of litigation if there’s a sudden stock price drop that accompanies them. [Editor's note (EO): Long-term experience and other credentials in place of or in addition to a CPA certificate per se may also help qualify a CFO, but there is a lot to be said for holding a CPA certificate and a fair amount of CPA experience to fulfill the role of CFO, including practicing professional skepticism, understanding testing of accounts, significant experience reviewing external reporting and internal controls, etc.]

“I don’t think there is any fire there,” Schey [American Apparel attorney] said. “Most of the smoke revolves around weak internal controls, being worked on as we speak. They may not be the most seasoned Wall Street players, but when it comes to ethics and integrity, they have it in spades.”

In spite of their lawyer’s exhortations, I’m afraid the U.S. Attorney's Office thinks ethics and integrity may be the bigger issue.

[Editor's note (EO): In the guest post above, McKenna writes about the importance of ethics and integrity. Ethical leadership and Integrity have been among the pillars of FEI's mission since its founding, over 75 years ago. Additionally, FEI members sign a Code of Ethics annually, which states, among other things, that all FEI members will "Share knowledge and maintain skills important and relevant to constituents' needs," and "Proactively promote ethical behavior as a responsible partner among peers, in the work environment and the community." To keep up on the latest issues, read more about our upcoming conferences, webcasts, research and advocacy activities. FEI, an international organization, also has local chapters where you can network with peers.]

Wednesday, August 18, 2010

FASB Releases Proposals On Pensions, Leases

Earlier today, FASB released proposals relating to pensions and leases.

The Proposed Accounting Standards Update—Plan Accounting—Defined Contribution Pension Plans (Topic 962): Reporting Loans to Participants by Defined Contribution Pension Plans, represents a consensus of FASB's Emerging Issues Task Force, and carries a comment deadline of Sept. 7.

Separately, the broad-ranging Proposed Accounting Standards Update—Leases (Topic 840), has a comment deadline of Dec. 15.

Loss Contingency Comment Deadline Extended By FASB; Feedback Sought on Disclosure Framework Criteria

FASB announced earlier today that it has extended the comment period on its proposal on Loss Contingencies. The original comment deadline was this Friday (Aug. 20); the extended deadline is now Sept. 20.

The board reached this decision, noted FASB Chairman Robert Herz, after considering initial feedback on the proposal and the related original 30-day comment deadline.

Props to FEI Senior Manager Lorraine Malonza who listened to the webcast of today's FASB board meeting and gave me a heads up while I am on vacation (no, I am not at the Jersey Shore!)

Disclosure Framework Criteria
Also at today's meeting, the FASB noted they are considering the following criteria for disclosures under their Disclosure Framework project, i.e. that disclosures should:

  1. Add relevant information that is essential for primary users to understand the entity’s financial position including liquidity and financial flexibility, and changes in financial position, including financial performance and cash flows.
  2. Be a faithful representation of the phenomena the information purports to represent.
  3. Provide benefits that justify the costs of reporting that information.
Further, as noted in FASB's Summary of Board Decisions:

The Board directed the staff to seek input on the potential criteria from members of the project’s resource group and other interested constituents to determine whether the criteria function as intended or might have undesirable consequences.

Monday, August 16, 2010

Are You Ready for Global Sustainability Reporting - GUEST POST by Tom Hood, Exec. Dir. & CEO, MACPA

NOTE: While I am on vacation, I invited some guest posts from popular bloggers. Following is a guest post from Tom Hood, Executive Director and CEO of the Maryland Association of CPAs (MACPA). Together with Bill Sheridan of MACPA, in addition to the many other hats he wears in the MACPA and national acccounting community, Tom is coauthor of various MACPA Blogs, including CPA Success. Tom's guest post follows.

On Monday 2nd August 2010, the formation of the International Integrated Reporting Committee (IIRC) was announced. Led by Prince Charles and The Prince’s Accounting for Sustainability Project (A4S) and the Global Reporting Initiative (GRI) in an attempt to add a globally accepted set of standards for accounting for sustainability. The website states the intent of this new organization as follows:

“The IIRC has been created to respond to the need for a concise, clear, comprehensive and comparable integrated reporting framework structured around the organization’s strategic objectives, its governance and business model and integrating both material financial and non-financial information.

The objectives for an integrated reporting framework are to:
a. support the information needs of long-term investors, by showing the broader and longer-term consequences of decision-making;

b. reflect the interconnections between environmental, [NOTE A] social, governance and financial factors in decisions that affect long-term performance and condition, making clear the link between sustainability and economic value;

c. provide the necessary framework for environmental [NOTE A] and social factors to be taken into account systematically in reporting and decision-making;

d. rebalance performance metrics away from an undue emphasis on short-term financial performance; and

e. bring reporting closer to the information used by management to run the business on a day-to-day basis.”

This is clearly another form of global convergence as the European community has led the world in “sustainability reporting”.

NOTE A (Editor's note - see also front page story by Justin Gillis in Sunday Aug. 16 New York Times: In Weather Chaos, A Case for Global Warming.)

NOTE B: (Editor's note: see also our Jan. 27 post: SEC Votes to Issue Interpretive Guidance on Climate Change Disclosures)

If you are interested in being considered as a guest blogger during my vacation in August, please contact me at

Quick Fraud Tips for Board Members - GUEST POST by Sheila Keefe

NOTE: While I am on vacation, I invited some guest posts from popular bloggers. Following is a guest post from Sheila Keefe, a CPA and Certified Fraud Examiner (CFE) whose website is, blog is Following is the guest post from Sheila.

The responsibilities of board members seem to be growing by the day, leaving many board members wondering how to prioritize the many ‘best practices’ out there to make the most effective use of their time. Luckily, there are a handful of fraud prevention and detection tools that have been proven to reduce fraud losses that can be done in just a few days a year. The following are five of the most cost-effective fraud prevention and detection tips out there:

1. Whistleblower Hotlines:
Forty percent of frauds are discovered through anonymous tips, with 67% of tips received through a hotline for organizations that offer them, making whistleblower hotlines the most effective fraud detection technique available. (Source: The Association of Certified Fraud Examiners 2010 Report to the Nations on Fraud and Abuse, There are many highly qualified, national providers of whistleblower hotlines that provide companies with their own 800-number and handle complaints and tips, with 24/7/365 coverage. These companies have experienced operators who will conduct a 15-20 minute intake interview and deliver an incident report to be distributed to key personnel within your organization. A provision for anonymity to any individual who willingly comes forward to report a suspicion of fraud is key to encouraging such reporting and should be a component of the organization’s policy.

Additionally, the Association of Certified Fraud Examiners 2010 Report to the Nations on Fraud and Abuse ( indicates that just 66% of tips come from employees, so it’s important to extend the pool of available informants to include vendors and customers. Many companies, like Cisco Systems, include contact information for the company’s whistleblower hotline on the company’s website, customer receipts and vendor code-of-conduct agreements.

2. Surprise Audits:
The threat of detection is a powerful tool. What’s great about surprise audits is that unlike regular audits that can often involve large samples size, surprise audits serve their purpose using very small sample sizes. The Association of Certified Fraud Examiners 2010 Report to the Nations on Fraud and Abuse ( indicates that surprise audits are used only 28% of the time, yet reduce fraud losses by over 50%.

3. Employee Support Programs:
According to Cressey’s fraud triangle, there are three elements that must be present for an ordinary person to commit fraud: opportunity, rationalization and financial pressure. Interviews with fraud perpetrators indicate that many fraud perpetrators knew of ways to steal well before they actually started stealing, noting that they did not steal until they experienced financial pressure. This information paired with the fact that over 85% of perpetrators are first offenders (Source: ACFE 2010 Report to the Nation on Fraud and Abuse) indicates that some fraud perpetrators are really just good people caught in a bad financial situation who have chosen stealing money as their last, best option for relieving financial pressure. So by offering employees psychiatric and credit counseling at a time when it’s most needed, before they steal, companies can help redirect employees efforts to more productive solutions to their problems than stealing.

4. Code of Ethics and Ethics Training:
Having a Code of Ethics and performing routine ethics training have both been shown to reduce median fraud losses by over $100,000 per incident. (Source: ACFE 2010 Report to the Nations on Fraud and Abuse, Having a Code of Ethics and providing training is so important because employees must be aware of the company’s Code of Ethics in order to investigate and discipline fraudulent acts. Many fraud perpetrators have successfully avoided punishment because they were able to assert that they did know any better. Further, ethics training can be embraced as an opportunity to improve morale when employees can be shown that reducing fraud will improve job security for all by eliminating a drain on revenues that averages 5%, a margin few organizations can comfortably absorb in this economy.

5. Segregation of Duties:
Trust is not a control, and certain duties must be segregated so that the same employee cannot both steal and conceal. In evaluating which duties must be segregated, be sure to pay special attention to tasks that allow the same person to control any two of the following elements of a transaction: authorization, custody or recordkeeping.

For example, a clerk who posts customer payments should not also be able to issue credit memos. Here’s another example, the clerk who opens purchase orders should not be able to alter master vendor files or receive goods. In working with smaller accounting departments, it is possible to include non-finance personnel to perform one side of an incompatible control pair. The use of ‘exception reports’ is also helpful in providing oversight when segregating duties is not feasible. Exception reports are any report that would allow management to identify a red flag or anomaly. For example, a supervisor could periodically review a report of credit memos issued or changes to master vendor files. With segregation of duties, it is possible to improve controls by merely shuffling duties, rather than adding staff.

In conclusion, some of the best fraud prevention and detection tools are the easiest to implement. So, for board directors concerned about reducing fraud, the use of the most cost-effective methods, including whistleblower hotlines, surprise audits, employee support programs, code of ethics/ethics training and segregation of duties, will go a long way toward satisfying the ever-expanding scope of director responsibilities.

[Editor's note: in addition to resources availalble at, check out the Committee of Sponsoring Organizations of the Treadway Commission (COSO)'s website at FEI, along with the AAA, AICPA, IIA, and IMA are the five sponsoring organizations of COSO.)

If you are interested in being considered as a guest blogger for the FEI blog while I am on vacation in August, please contact me at

Friday, August 13, 2010

Catch Us If You Can - GUEST POST by Sara McIntosh

NOTE: While I am on vacation, I invited some guest posts from popular bloggers. Following is a guest post from Sara McIntosh, author of the Sara McIntosh Blog, and of the recently released book, Shell Games.

Video Credit: Dave Clark Five, appearing on Shindig, Circa 1965, via YouTube

I’d like to start this blog post out with a shared assumption—we do that in accounting all the time, so hopefully it’ll be familiar territory. In fact, assumptions are the very basis of accrual accounting. And with respect to this blog post, imagining a shared set of assumptions will help illustrate (hopefully quite simply) why the new financial regulations will most likely NOT prevent another subprime mortgage security crisis.

Our starting assumption for the post is this: Assume there was fraud imbedded in at least some of the bundled subprime mortgage securities extending far beyond liars’ loans and petty frauds at the homeowner/initial lender level. Additionally, assume these massive financial black holes (mortgage-backed securities) were intentionally created to steal billions of dollars out of the system.

Those of you who’ve read my financial thriller, Shell Games (available at, know it’s a rocking, sexy, fictional account about billion-dollar frauds embedded by a Wall Street firm called Lemon Brothers into many of the bundled subprime mortgages they issued. Similar to real life, when some of the plans go awry, the resulting fallout causes a global financial crisis.

As Robert Meixner of Port Saint Lucie, FL wrote in his review of Shell Games,
“Much of what passes for explanation of the current recession has to do
with the subprime mortgage business, and much of what is said about it doesn’t
make any sense to me. The numbers don’t add up. I need a better explanation, and
one that appeals to my logic as an accountant. A conspiracy theory that offers
just such an explanation has been advanced by author, Sara McIntosh in her novel
. . .”

This assumption of widespread fraud in our economy’s mortgage-backed assets is also well-founded in reality. For instance, Catherine Austin Fitts, former Assistant Secretary of Housing in the first Bush administration uncovered (in real life) a scheme she estimated meant frauds in up to 40% of the mortgage-backed securities. She says because no one wanted to address the situation, these frauds were never cleared out of the government’s asset portfolios. It took a native New Yorker and two generations of tracking to catch onto the frauds the crooks were perpetuating. Catherine outlines the whole incredible scam in her Voice of America radio interview with Jay Taylor—here’s the link.

Unfortunately, I doubt the new financial regulations are going to do much to dismantle (or even monitor) the conditions that make it so easy to bury fraud at every step of the process. You see, even though much of the “investing public” and government regulators don’t seem to recognize it—you get what you pay for when it comes to professional services, and not much more. And when it comes to regulators like the Securities and Exchange Commission, they aren’t paying the public accountants or credit rating agencies to do anything for them.

Right now, there’s not a client in the entire process willing to compensate the audit and credit rating service providers, or even provide them with access to relevant data, for either service provider to be able to catch intentional misrepresentations or outright frauds with these and other sophisticated, multi-tiered financial products in advance of another meltdown.

For example, let’s assume a fairly simple fraud right at the point of security issuance. Assume someone wanted to fraudulently represent that there were more mortgages backing a certain bundled mortgage security than there actually were, so that when the associated real mortgages were paid off, they could extract the excess cash without anyone missing it.

Would anyone catch them? Quite likely not.

Starting with the first step in hiding the fraud: The only outside party requirement before issuing the security is to obtain a credit agency rating for the security. The credit rating firms don’t actually audit the underlying mortgages to make sure there are no fraudulent ones. They ask the company to provide standard disclosures to them about things like default rates and such, and do their own analysis from thereon based on their own assumptions about how much they can rely on the information provided by the company. As non-auditors they are basically forced to rely on the representations of management (and their own knowledge of the company and its industry) to make their credit rating “forecasts.” No wonder they’re so worried about the new regulations causing them to assume liability related to the final accuracy of their credit rating “predictions.” (Note that as of the writing of this post, even this first third-party “review” step has been “temporarily” suspended by the SEC—see my blog post entitled “Time Kills All Deals.”) It was pretty easy to get the first rung of the fraud past them in our assumed post example.

Phase Two of getting further away from fraud discovery: As soon as the security is constructed and has received its credit rating it’s sold off. The issuer (who in my fictional example embedded the fraud) has received cash for their fraudulent transactions. There’s nothing really left to audit on the issuer’s balance sheet and the cash received is more than enough support to recognize the revenue. Assuming cash payments to settle the underlying mortgages (and clear the fraud out of the system) were also already transacted by the cutoff balance sheet date, there really is nothing to audit on the issuer’s books.

Third step completed and you’re golden! (Translation: the fraud will most likely never be discovered.) The first purchaser of the bundled mortgage security may or may not still be holding onto it when the relevant balance sheet period end arrives. However, no matter who is holding onto the financial hot potato (mortgage-backed security), it is highly unlikely the auditors reviewing the “asset” will actually try to tie the carrying value back to underlying mortgages. Instead they’ll calculate “lower of cost or market” book value in two main ways: valuing the asset at what the company paid for it (if they paid it, it must be worth it) and if possible getting a “market” valuation from a broker who sells similar securities.

So as you can see in this simple example, unless the details of the new financial rules actually address changing the way in which the value of these securities is tested/audited, we should expect whatever greed and lack of morality that caused the first financial crisis to be too tempting and cause another one down the line. Without real system-wide changes, these mortgage-backed securities are just too easy to manipulate for big bonuses and perpetuating massive fraud schemes, to end the fun and games.

Don’t even get me started on the difficulties auditing securities that aren’t even tied to real assets (e.g. indexed mortgage securities) or frauds that can be layered into the process every time these complex financial instruments trade from portfolio to portfolio. It’s taking me a series of fiction novels to showcase that!

In closing, I remind you, this is more than just fiction. The really scary thing is that right now trillions of dollars worth of these mortgage-backed securities make up a majority of our U.S. Treasury’s own balance sheet. What would happen if we had to take a massive 30% to 40% write-down due to as yet undiscovered frauds?

Ciao for Now,

Sara McIntosh

NOTE: If you have an established blog or publication and would like to submit a guest blog post for the FEI blog, please contact me at to discuss.

Thursday, August 12, 2010

Small Co's Relieved of SOX 404(b) Duties, Under Financial Reform Law - GUEST POST by Melissa R. Hoffmann

NOTE: While I am on vacation, I invited some guest posts from popular bloggers. Following is a guest post from Melissa R. Hoffmann, Editor, New York State Society of CPAs, and one of the contributing bloggers on NYSSCPA's CPA Blog.

Owners and auditors of small companies got a gift by way of the Dodd-Frank Wall Street Reform and Consumer Protection Act, which now provides for them a permanent exemption from 404(b) reporting requirements put in place by the 2002 Sarbanes-Oxley Act.

Sarbanes-Oxley, a response to the Enron and WorldCom scandals in 2001, mandated that a publically traded company have an independent auditor attest to management’s assessment of the effectiveness of its internal controls. While large, accelerated filers already comply with this rule, the Securities and Exchange Commission (SEC) repeatedly delayed implementation for smaller companies with public floats of less than $75 million.

Eight years later, that implementation date was still being pushed back—until late 2009, when the SEC went on record saying that there would be no more delays: The smallest companies would be required to obtain the 404(b) attestation for the annual reports of companies with fiscal years ending on or after June 15, 2010.

The commission decided to give that final deadline after the release of a cost-benefit analysis conducted by the SEC showed that smaller companies pay a disproportionately higher cost to comply with 404(b) filing rules but that a significant portion of these costs are non-recurring, with the burden attenuating over time.

But the financial reform bill, signed into law July 21, made that deadline moot. No, there won’t be any more implementation delays. But that’s because there won’t be any implementation at all.

A provision of the financial reform bill—Section 989G—turns these repeated implementation delays into a permanent exemption, saying that the part of Sarbanes-Oxley mandating 404(b) compliance not apply to “non-large, non-accelerated” filers. That particular section of the legislation also requires the SEC to conduct a study examining how best to reduce 404(b) compliance costs for companies with market capitalization between $75 million and $250 million while still maintaining investor protection. The study is to be released to Congress no later than nine months after the bill becomes law.

NOTE: If you have an established blog or publication and would like to submit a guest blog post for the FEI blog, please contact me at to discuss.

Wednesday, August 11, 2010

FASB/IASB's Rev. Rec.Proposal - GUEST POST by Ron Fink, CFOZone

NOTE: While I am on vacation, I invited some guest posts from some popular bloggers. Today's guest post below is from Ron Fink, Editor, CFOZone.

While convergence of international accounting standards may be a painfully slow process, US and international standard setters took a big if largely unnoticed step forward last June with a joint proposal for a new revenue recognition standard. In fact, no such standard currently exists within US GAAP, as various pronouncements by the Financial Accounting Standard Board over the years have largely been piecemeal responses to developments at the Emerging Issues Task Force that have vexed the board to one degree or another.

Indeed, the lack of an overarching standard for the top line on publicly traded companies' P&Ls has long been considered a huge gap in GAAP, so to speak. But despite its potential significance, the new proposal has gone largely unnoticed or at least remarked upon, particularly in the mainstream press, perhaps because most if not all eyes there have been on new fair-value rules that have stirred intense opposition from within the banking industry.

That said, a new, in-depth analysis of the proposed revenue recognition standard that was recently released could lead to more public awareness, at least for a while. For further details, refer to my August 9 blog post at, "Better Revenue Recognition at Long Last?"

NOTE: If you have an established blog or publication and would like to submit a guest blog post for the FEI blog, please contact me at to discuss.

Saturday, August 7, 2010

FASB Joins Twitterverse

Last week, the Financial Accounting Foundation, overseer of the Financial Accounting Standards Board (FASB) and the Governmental Accounting Standards Board (GASB) announced it has joined the Twitterverse, using the handle @FAFNorwalk Whether the FAF/FASB/GASB's tweets will be limited to press releases (as their first two tweets have been) or extend into informal opinions of board/staff members remains to be seen.

In making this move, FASB joins other famous twitterers who have many followers, including Oprah Winfrey, Larry King, Ashton Kutcher, and the SEC. (The IASB and PCAOB, to my knowledge, have not yet joined Twitter, although they were among the first to offer podcasts of board meetings and other information). Here's a list of the top twitterers based on number of followers via Twitterholic, and here's an interesting article with another take: On Twitter, It's Follower Quality, Not Quantity, That Matters (NYT 8/7/10).

As you may know, the FEI Blog has been on Twitter for a number of years, at @feiblog ( . And you can stay up to date with other FEI news at @feinews ( .

For those of you who are not that familiar with Twitter, you can get a pretty good introduction by watching "Twitter Frenzy" from the March 2, 2009 episode of Jon Stewart's "The Daily Show" on Comedy Central.

Friday, August 6, 2010

Blue Ribbon Panel on Private Co. Standards Seeks Comment

On Aug. 5, 2010, the AICPA/FAF/NASBA "Blue-Ribbon" Panel on Standard Setting for Private Companies announced it is seeking written input from constituents in the form of responses to seven questions.

Responses will assist the panel in discussing how accounting standards can best meet the needs of United States users of private company financial statements and making recommendations thereon to the Financial Accounting Foundation Board of Trustees.

Varioius FEI members serve on the Blue Ribbon Panel, including the chair of FEI's Committee on Private Company Standards, Daryl Buck, and they encourage your participation. Click here to respond. Responses are due on Sept. 15, 2010.

Read more about FEI's Committee on Private Company Standards (CPC-S) here.

Thursday, August 5, 2010

PCAOB Adopts New Risk Assess. Stds; Issues Release on Failure to Supervise - GUEST POST by Francine McKenna, Re: The Auditors

Following is a GUEST POST from my BBF (Best Blogger Friend), Francine McKenna, Managing Editor of the popular blog RE: The Auditors. I am on vacation the next two weeks and am pleased to have Francine kick off some guest posts from other bloggers. Visit her blog at and on twitter at

If you are a blogger interested in potentially providing a guest post in the FEI blog during the next few weeks, please contact me by email at

Reported by Francine McKenna, Guest Blogger today:

The Public Company Accounting Oversight Board held an Open Meeting this morning, Aug. 5 to address the following important items of business:

  • The adoption of eight auditing standards and related amendments that would revise the requirements for assessing and responding to risk during an audit., to cover two important issues, and

    A proposed release to address the PCAOB’s obligation under the Sarbanes-Oxley Act of 2002 to impose disciplinary sanctions on registered public accounting firms and their supervisory personnel who fail to reasonably supervise associated persons.

PCAOB Board Unanimously Adopts Suite of Risk Assessment Standards
The Board voted unanimously to adopt the suite of risk assessment standards, Auditing Standards No. 8 through No. 15. These standards were originally proposed on Oct. 21, 2008, and then reproposed in revised form on Dec. 17, 2009. Here is a link to the press release.

The standards set forth requirements that enhance the effectiveness of the auditor's assessment of, and response to, the risks of material misstatement in the financial statements. They supersede six PCAOB interim standards and related amendments: AU sec. 311, Planning and Supervision; AU sec. 312, Audit Risk and Materiality in Conducting an Audit; AU sec. 313, Substantive Tests Prior to the Balance Sheet Date; AU sec. 319, Consideration of Internal Control in a Financial Statement Audit; AU sec. 326, Evidential Matter; and AU sec. 431, Adequacy of Disclosure in Financial Statements.

PCAOB Issues Release on Failure to Supervise
The Board also unanimously agreed to issue a release to address the PCAOB’s obligation under the Sarbanes-Oxley Act of 2002 to impose disciplinary sanctions on registered public accounting firms and their supervisory personnel who fail to reasonably supervise associated persons. Here is a link to the press release. The PCAOB’s proposed release highlights Section 105(c)(6) of the Act and seeks comment on conceptual approaches to rulemaking that would complement its application.

Through its inspections and investigations, the PCAOB has observed that supervision processes within firms are frequently not as robust as they should be, and that supervisory responsibilities are often not as clearly assigned as they should be," said PCAOB Acting Chairman Daniel L. Goelzer. "Today's Release seeks to highlight the Board’s views on the scope for using the authority provided in the Act to address those problems."

The purpose is twofold:

• To remind auditors and their firms that the Board has the authority under 105 (c)(6) to impose sanctions on registered public accounting firms and their supervisory personnel for failing to reasonably supervise associated persons.

• To solicit comments for a rulemaking proposal that covers the full scope of supervisory professionals in a firm, not just the engagement partner.

PCAOB Board Member Steve Harris said:
“I think it is absolutely clear... that that system was intended to include accountability all the way up to the top of the firm. … One of the frustrations at the time -- was …the inability to hold people at the top of the chain accountable for problems that had occurred on their watch.”

The PCAOB is soliciting public comment on the concepts discussed in Part II of the Release which focus on possible rulemaking or standard setting that would require firms to make and document clear assignments of the supervision responsibilities that are already required to be part of any audit practice. The comment period is open until November 3, 2010. (corrected from original post)

PCAOB Request to Congress to Amend Sarbox

Finally, PCAOB Acting Chairman Daniel Goelzer asked his legislative team to draft a request to Congress to amend the Sarbanes-Oxley Act to change the PCAOB’s rules regarding the assumption of privacy for PCAOB disciplinary proceedings.

“No other auditor, investor, audit committee, or member of the media is entitled to know what the PCAOB considers to merit discipline, whom it has charged, what issues are being litigated, or whether the PCAOB staff has prevailed or not,” said Acting Chairman Goelzer. “The public is in the dark about how the Board uses its enforcement authority until there is a settlement or an SEC decision on the Board’s sanctions.

Under Sarbanes-Oxley, PCAOB investigations and disciplinary proceedings – from beginning to end - are conducted in private, with no disclosure to investors and the public unless or until charges are settled or all appeals at the SEC level are exhausted.

“The privacy provisions for our disciplinary proceeding are biggest impediments to investor protection in Sarbanes-Oxley," said PCAOB Board Member Bill Gradison.”

There is no assumption of privacy for SEC disciplinary proceedings against auditors once a decision on sanctions is reached. This misalignment, according to the PCAOB, may encourage delay and ongoing litigation by the audit firms rather than transparency and accountability for the benefit of investors and the profession. See related press release.