Risk & Compliance

Andrew and Lea Fastow Agree to Plead Guilty

Enron's former CFO faces 10 years in prison. Also: are the worst of the scandals behind us?; CFO becomes chairman as Oracle splits leadership roles...
Dave Cook and Stephen TaubJanuary 14, 2004

Former Enron Corp. chief financial officer Andrew Fastow and his wife, Lea, a former Enron assistant treasurer, will plead guilty on Wednesday, according to the Houston Chronicle.

Andrew Fastow is scheduled to plead guilty before U.S. District Judge Kenneth Hoyt; some time afterward, Lea Fastow is set to plead guilty before U.S. District Judge David Hittner.

Andrew Fastow’s deal involves a 10-year prison sentence, reports The New York Times. According to the Times, it is unclear what charges he would plead guilty to; he faces 98 counts including insider trading, fraud, money laundering, and tax evasion. It is also unclear whether the former CFO — who will become the highest-ranking executive to plead guilty in the criminal investigation into Enron’s collapse — will offer testimony against former chairman Kenneth Lay or former CEO Jeffrey Skilling. Neither Lay nor Skilling have been charged, notes the Times, and both maintain their innocence.

The plea arrangements come less than a week after an earlier pair of agreements fell apart. Lawyers for Lea Fastow had reportedly agreed to a sentence of five months, but Hittner reserved the right to impose a longer term after a 60-day pre-sentencing report. When that agreement could not be finalized, Andrew Fastow’s agreement to plead guilty was put on hold.

Lea Fastow is now expected to plead guilty to one count of filing a false tax return and to acquiesce to the pre-sentencing report. According to lawyers involved in the case, reported the Chronicle, her likely sentence will be between 10 and 16 months in prison.

(Editor’s note: For much more on the continuing responses by corporations and regulators to financial engineering and white-collar crime, read our special reports on off-balance-sheet financing and corporate cleanups.)

Are the Worst of the Accounting Scandals Behind Us?

When it comes to corporate restatements, you can look at the numbers in more ways than one.

Last year, the total number of restatements slipped a bit, from 330 in 2002 to 323 in 2003, according to a study just released by the Huron Consulting Group. That would suggest we’ve passed the peak, but just barely; 2001, by comparison, saw only 270 restatements.

On the other hand, the number of restatements of audited annual financials rose to a record high of 206 in 2003, up from 183 in 2002, according to Huron.

“While investors rely on both quarterly and annual financial statements of public companies, there is a different level of procedures and responsibility assumed by the auditors for each,” the consulting firm points out. “Annual financials have a higher level of effort and association required since an audit opinion is rendered.”

Furthermore, if you compare the number of restatements with the number of public companies filing reported data, the numbers appear even worse. According to a Huron study released a year ago, points out The New York Times, the number of public companies registered with the Securities and Exchange Commission fell 14 percent from 1999 to 2002, from nearly 10,600 to fewer than 9,400. That would mean that the percentage of public companies needing to restate has also been rising.

What were the most frequent reasons given for restatements?

During the past five years, revenue recognition was the most frequent cause, accounting for nearly one-fifth of all restatements, according to Huron. Last year, however, there were “just” 63 restatements related to revenue recognition — a 26 percent decrease from 2002, when revenue-recognition restatements reached an all-time high.

The new number-one issue for 2003? Reserves and contingencies. The number of restatements involving this category rose to 68 last year, from 53 in 2002, and just 21 in 1999, according to the study.

Reserves and contingencies include accounting errors related to accounts receivable and inventory reserves, restructuring reserves, accruals, and other loss contingencies. These are among the most judgmental accounts in a company’s financial statements, Huron points out, since they are subject to an estimation process. These restatements, however, do not simply reflect changes in estimates; they also reflect flawed judgments due to the oversight or misuse of facts, fraud, or a misapplication of generally accepted accounting principles.

The fact that reserves were the biggest source of restatements is puzzling to a number of experts.

For example, Dennis R. Beresford, a professor of accounting at the University of Georgia, pointed out to the Times that generally, changes in estimates of a future cost to a company don’t require a restatement. This mean that companies either deliberately overstated or understated needed reserves, or they found significant errors, he added.

For there to be fraud, Beresford continued, a company might overestimate needed reserves to reduce current profits and have money available in later, leaner years, or underestimate them in order to bolster revenue in the current period.

CFO Becomes Chairman as Oracle Splits Leadership Roles

Business software maker Oracle Corp. named chief financial officer Jeff Henley as chairman. He replaces company co-founder Larry Ellison, who will continue as chief executive officer.

Splitting the roles of chairman and chief executive officer has been a leading goal of many advocates of corporate reform, who question the concentration of too much power at the top of corporations.

In addition, Oracle — which has functioned without a president since Ray Lane left the company in 2000 — will now have two co-presidents. Safra Catz and Charles Phillips will share the job and report to Ellison. Catz will continue in her current role as head of global operations; Phillips will oversee sales, marketing, and consulting. Henley will step down as chief financial officer when a successor is found, reported Reuters.

“Who will be CFO is going to be important,” said State Street Corp. analyst Heather O’Loughlin, according to the Boston Globe. (State Street owns shares of Oracle.) “The Street trusts Jeff Henley.”

“Jeff Henley is one of the most respected executives in the technology industry,” said Ellison in a statement. “Jeff’s been Oracle’s CFO for nearly 13 years. He’s an expert on corporate governance and accounting. I’m looking forward to working with Jeff for years to come.”

KPMG Shakes Up Its Tax-Shelter Business

Having faced criticism in the U.S. Senate and an investigation by the Internal Revenue Service, KPMG has announced a shake-up of its controversial tax-shelter business.

The Big Four accounting firm said that deputy chairman Jeff Stein, formerly vice chair of Tax Services, will retire at the end of this month; Jeff Eischeid, partner-in-charge of the Tax Practice’s Personal Financial Planning practice, will be placed on administrative leave; and Richard Smith, who has served as vice chair of Tax Services for the past two years, will take on different practice responsibilities.

“KPMG is committed to fill our role as a responsible corporate steward,” the accounting firm said in a statement. “These changes are consistent with our ongoing consideration of the firm’s tax practices and procedures, and reaffirm KPMG’s commitment to the highest standards of professional practice and responsibility.”

KPMG’s tax shelter business received a lot of criticism several from months ago from a Senate committee and has been investigated by the IRS. Last month the Justice Department accused KPMG of delaying an IRS probe of the firm’s tax-shelter activity by being tardy about handing over crucial documents.

KPMG had argued it wasn’t a tax-shelter promoter.

“In absolutely no instance has KPMG asserted privilege for the purpose of delay or any other improper purpose,” the accounting firm reportedly told The Wall Street Journal in December. “We continue to cooperate with the IRS in its inquiries.”

From 1997 through 2001, KPMG collected $124 million in fees for tax shelters that cost the government at least $1.4 billion in lost revenue, according to estimates released in a report by minority staff of the Senate Permanent Investigations subcommittee, wrote the Times.

HealthSouth Discovers Governance

Better late than never.

After major restatements and at least 15 guilty pleas, HealthSouth Corp. has discovered good governance.

The embattled health-care company announced a slew of changes aimed at improving its corporate compliance. Of course, a number of the new measures are either mandated by the Sarbanes-Oxley Act or the stock exchanges.

The company announced that it named John Markus as senior vice president and chief compliance officer. Markus, former senior vice president of corporate compliance for Fresenius Medical Care North America, will manage HealthSouth’s regulatory compliance and internal audit programs.

Markus, who is an attorney, has more than 10 years of experience in corporate compliance, having also worked with Oxford Health Plans and National Health Laboratories Inc. He will report to the CEO as well as the compliance committee of the board of directors.

HealthSouth also revised its corporate governance guidelines to incorporate provisions including the following:

  • Three-quarters of the members of the board of directors must be independent.
  • A new position, non-executive chairman, will be filled by an independent director.
  • Members of the board are limited in the number of outside directorships they may hold.
  • Non-management directors will meet, without management directors, on a regular basis.

Short Takes

  • The Pension Benefit Guaranty Corp. will announce a $10 billion deficit this week, a congressman said on Tuesday, according to Reuters. The agency announced in October that it had a record $8.8 billion deficit as of August, compared with a fiscal 2002 deficit of $3.64 billion and a $7.73 billion surplus the previous year.
  • An internal audit currently under court seal warned top executives at Wal-Mart Stores three years ago that employee records at 128 stores pointed to extensive violations of child-labor laws and state regulations requiring time for breaks and meals, according to The New York Times.

The audit of one week’s time-clock records for roughly 25,000 employees found 1,371 instances in which minors apparently worked too late at night, worked during school hours, or worked too many hours in a day. It also found 60,767 instances in which workers apparently did not take rest breaks, and 15,705 instances suggesting that employees had worked through their mealtimes, the paper reported.

  • Kaiser Aluminum Corp. told a federal bankruptcy court that it cannot afford the ongoing and future costs of retirement benefits, including $60 million a year in post-retirement medical plan payments.

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