Risk & Compliance

I Did Nothing Wrong, Says Fastow

Ex-Enron CFO pleads not guilty to all 78 charges in indictment; says his actions were approved by senior management. Elsewhere: Who will replace Pi...
Stephen TaubNovember 7, 2002

Former Enron Corp. chief financial officer Andrew Fastow pleaded not guilty to a 78-count indictment that he defrauded the energy trader and its shareholders.

Fastow, appearing yesterday before U.S. Magistrate Marcia Crone, stated that he was innocent of charges ranging from fraud to money laundering to obstruction of justice.

“Your honor, in answer to each of the charges I plead not guilty,” he said in the federal courthouse in Houston, according to reports. Fastow was indicted last week.

If convicted, the former Enron CFO could spend the rest of his life in jail. Fastow has been free on $5 million bail since he was initially charged in early October.

A status hearing is scheduled for January 13.

Fastow’s attorneys have reportedly argued that he is not guilty of any wrongdoing because his actions were approved by Enron senior managers and the board of directors.

SEC: Vacancies?

Now that Securities and Exchange Commission chairman Harvey Pitt has tendered his resignation, the big question is: Will others be following him out the door?

Observers are already predicting that new Public Company Accounting Oversight Board chairman William Webster will offer his resignation within the next few days.

In addition, there are new rumblings that SEC chief accountant Robert Herdman is also feeling pressure to resign. The SEC indicated on Wednesday that Herdman was “doing his job” and would not comment on speculation over his future, according to ft.com.

If Herdman leaves, however, it would leave the SEC with three critical positions to fill: chairman, chief accountant, and head of the accounting oversight board.

The likely candidates for the three slots?

Several names have reportedly come up for Pitt’s job in informal discussions between White House officials and Washington lawyers. The list includes Peter Fisher, the undersecretary for domestic finance at the U.S. Treasury, and James Doty, a former candidate for the SEC chairman’s job and a friend of the President.

Reuters yesterday mentioned several other potential candidates for Pitt’s job: SEC commissioners Paul Atkins and Cynthia Glassman, Gary Lynch, and former federal judge Stanley Sporkin.

Lynch and Sporkin are both former SEC enforcement chiefs.

One rumored candidate has already removed himself from the short list. Speaking yesterday before an audience at the Securities Industry Association annual meeting, former New York City mayor Rudolph Guiliani said: “I’m not looking for a job. This is not the time for me to go back into government.”

A newspaper article had mentioned Guiliani as a possible replacement for Pitt. The ex-NYC mayor is currently working with authorities in Mexico on reducing that country’s crime rate.

Although Pitt has promised to stay on at the SEC until a replacement is found, Reuters reports that President Bush may name an interim chairman instead. Translation: the White House apparently wants Pitt out now.

SEC Proposes New Rules for Lawyers

The unsettled state at the SEC does not appear to be hampering the efforts of the commission’s staff.

The SEC on Wednesday proposed new rules for corporate lawyers, which will require attorneys to report any wrongdoing at companies they work for.

A final version is expected to be written by late January 2003.

The new rules for lawyers were mandated by the Sarbanes-Oxley Act, which was passed this summer.

The new standards must include a rule requiring an attorney to report “evidence of a material violation of securities laws or breach of fiduciary duty or similar violation by the company or any agent thereof” to the chief legal counsel (or CLO) and the chief executive officer of the company (or the equivalent).

If the senior executives do not respond appropriately to the evidence, the new rules require the lawyer to report the evidence to the audit committee, another committee of independent directors, or the full board of directors.

“It clearly changes the attorney-client relationship…These changes are absolutely necessary,” said SEC commissioner Roel Campos, according to published accounts.

Adelphia Sues Deloitte & Touche

Adelphia Communications Corp. has filed suit against Deloitte & Touche LLP, its former outside auditor, for its role in “one of the most egregious instances of corporate self-dealing and financial chicanery in United States corporate history.”

The lawsuit charges D&T with “professional negligence, breach of contract, fraud, and other wrongful conduct.” As a direct result of Deloitte’s own wrongful conduct, “Adelphia has suffered very large damages and was ultimately forced to file for bankruptcy protection,” according to the suit.

“Deloitte’s audit failures resulted in billions of dollars in damages to Adelphia, our investors and employees,” said Adelphia management in a statement. “The Rigas family never could have accomplished their wrongful acts had Deloitte fulfilled its professional responsibilities to Adelphia by disclosing the corporate abuses that it knew, and should have known, were taking place.”

Adelphia’s new management added: “Deloitte brought further harm to Adelphia by failing to admit its wrongdoing and attempting to cover-up its breaches.”

Specifically, the lawsuit charges:

  • Deloitte failed to provide the company, its audit committee, and its independent directors with independent, competent audits.
  • Through its audits and access to Adelphia’s books and records, Deloitte knew of much of the Rigas family’s self-dealing and looting of Adelphia. “Nearly all of the rest of the Rigases’ wrongful conduct was readily apparent to Deloitte on the books and records that Deloitte reviewed,” asserted Adelphia management. “Thus, Deloitte should have known of all of the Rigases’ wrongful conduct and should have disclosed it to Adelphia’s audit committee and the independent members of Adelphia’s board.”
  • Deloitte failed to disclose the corporate abuses that it knew and should have known were taking place to the Adelphia audit committee or the independent members of Adelphia’s board. “Deloitte performed its audits and certified Adelphia’s financial statements without ever qualifying its audit reports,” the company added.

“Deloitte always rendered a favorable opinion on Adelphia’s ability to continue as a going concern. Despite the massive self-dealing by the Rigases, Deloitte did not even send a letter to Adelphia’s management (customarily referred to as a ‘management letter’) suggesting any changes in Adelphia’s corporate control practices.”

  • Deloitte acquiesced in the Rigas family’s desire to hide the true nature of Adelphia’s financial condition from the public, the independent members of the audit committee, and the board. Adelphia alleges that during D&T’s 2000 audit of the company, the accounting firm acquiesced to the Rigas family’s desire to hide more than $1 billion of debt that should have been disclosed in Adelphia’s financial statements.
  • Even after expressly considering the issues surrounding the events relating to Enron, Deloitte assured the Adelphia audit committee three days prior to the deadline for filing Adelphia’s 2001 financial statements that Deloitte had no significant issues with its nearly completed audit. “Deloitte even told the chairman of Adelphia’s audit committee that its audit for 2001 was one of the best audits of Adelphia that Deloitte had ever produced,” the cable company’s management added.

“These wrongful acts resulted in billions of dollars in damages to the company-damages which were preventable if Deloitte had acted consistently with its professional responsibilities as Adelphia’s outside auditor,” according to the lawsuit.

Adelphia said it is seeking compensation for all injury suffered as a result of D&T’s alleged wrongful conduct, as well as punitive damages.

Adelphia fired Deloitte & Touche on June 9, 2002, replacing it with PricewaterhouseCoopers.

REIT Accounting under Attack

Rouse Co., the giant shopping-mall operator, is under pressure to defend its accounting practices. The goings-on at Rouse have larger implications for all real estate investment trusts (REITs).

The Baltimore Sun reported late last week that David Fick, an analyst at Baltimore-based investment bank Legg Mason Wood Walker Inc., accused the company of improperly accounting for $25 million in expenses, enabling Rouse to report record quarterly earnings.

The paper reported that Rouse executives said the company did nothing wrong but acknowledged that they did not follow industry guidelines by excluding such expenses as bonuses and retirement costs from funds from operations (FFO).

FFO is a performance measurement widely used by REITs since the early 1990s. The idea behind the metric: to create a yardstick for gauging the performance of all REITs. But FFO excludes such items as depreciation and amortization expense.

Hence, the metric is not reported to the SEC and does not conform to generally accepted accounting principles.

“The real issue with FFO is there’s no common definition to what’s in FFO,” said Lynn Turner, a former chief SEC accountant who now teaches accounting at Colorado State University.

In an interview with the Washington Post, Turner said: “Investors aren’t able to compare one company to another in terms of FFO. There’s no definition out there that everyone is required to follow.”

But David Tripp, a Rouse vice president and director of investor relations, told theSun: “We felt what we were doing was providing the best measure of recurring income. We were upfront in how we were calculating our results. We don’t think it would have given you a very good big picture to have added those charges.”

Analyst Fick insisted, however, that Rouse was able to report record results only because the company excluded the $25 million it planned to spend by the end of the year on a signing bonus for a new executive and other employment-related costs.

“They should not be allowed to get away with this kind of misleading financial report,” Fick reportedly said. “We ultimately believe that they reported their earnings incorrectly.”

“Severance to people who are laid off is probably appropriately a onetime cost, but bonuses to executives and that kind of stuff are not,” Howard Schilit, head of the Center for Financial Research & Analysis Inc., told the paper. “It seems interesting to even have those two things in the same sentence.”

Matthew Ostrower, an analyst with Morgan Stanley, also told the Sun Rouse’s expenses should have been included in the earnings. “We do not agree with the way Rouse accounted for” funds from operations, he reportedly said. “We believe the $25 million charge should have been included in FFO.”

But, he added, “if we were to downgrade every mall REIT that violated the FFO rules at one time or another, we would likely have a sell recommendation on every mall REIT.”

That’s encouraging.

(Editor’s note: To see how well Rouse manages its cash, check out CFO PeerMetrix. Simply click here.)