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Mgmt 117

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The SEC, auditors, banks, and credit rating agencies can be seen as positive reinforcements for companies to use and practice legal forms of accounting. Even though this statement is true, it may not always be true. Sometimes their efforts are not enough or they do not even put the effort in. This paper will evaluate how these four systems of controls had failed to prevent different companies from using unethical forms of accounting practices to their advantage. In order to deal with issues regarding derivatives risks, the SEC made some changes involving their disclosure. The SEC found that companies were accounting for derivatives in different ways and wanted to make a more clear and universal way to disclose derivatives information. After this change was set, companies started telling investors more about their derivatives but not enough for the investors to know how much of the company’s profits were from fickle business. The SEC stated that companies needed to provide “material” information and the companies seen “material” as a word to be played with and worked around. The SEC failed to make a clear rule by having many of their terms used loosely. Due to lack of a concrete definition of what SEC wanted, companies were not encouraged to make clear disclosures and moved their operations offshore to avoid the SEC. Waste Management’s scheme of manipulating earnings was aided by auditors at Arthur Anderson. During an evaluation of Waste Management’s statements, auditors of Arthur Anderson noticed that expenses were being pushed into the future. The auditors notified Waste Management and there no action taken to correct the errors and the auditors considered the situation as temporary. The auditors would bring up the errors more than once but Waste Management would continue to ignore the requests. Arthur Anderson continued to sign off on annual reports and eventually they believed the offset was not required to be disclosed even though accounting rules prohibited the offset. When the auditors finally put out a statement that was accurate, it was too late. Arthur Anderson was fined seven million dollars from the SEC for their involvement in approving Waste Management’s financial statements. In the case of Waste Management, the auditors did not put their foot down when they had the chance. They should have forced Waste Management to correct the first mistakes that they had noticed. By not enforcing the rules in the first place, Waste Management knew they could continue to use Arthur Anderson auditors to sign off on their manipulated statements. The auditors showed weakness and Waste Management took advantage of them. Also, the fact that Waste Management was paying them over seven million for audit work and another eighteen million in other fees may have made the auditors decision of hiding the truth a little easier. The auditors of Arthur Anderson also failed to correctly oversee Enron’s forward curves. The auditors were looking at day-to-day changes in the values of trades very loosely and did not notice the manipulation of their forward curves. For example; they did not catch that these forward curves were moving up to three cents a day. Arthur Anderson auditors failed to see the evidence of manipulation by not efficiently examining the company’s statements. Their lack of determination and work ethic resulted in a missed opportunity to catch fraudulent accounting. When big businesses such as WorldCom went under, one would expect the banks that still had loans or money owed to them to be worried. This is not the case. The banks had a backup plan which made supporting companies such as WorldCom, who was a risk in the first place, less risky. The backup plan was to make credit default swaps with smaller companies such as insurance companies. These credit default swaps looked like simple transactions when they were really leveraged bets on companies defaulting. These swaps helped banks shift the risk to other companies. With the backup plan in place, banks like J.P. Morgan and Citigroup had no incentive to look deeper into WorldCom’s accounting practices or even try and get out of business with them when they were obviously failing. The money that the banks lost in the case of WorldCom going bankrupt, they made up with swaps. Without credit default swaps, companies such as Enron could have taken out a major bank and the accumulated bankruptcies of Enron, Global Crossing, and WorldCom would have crushed the banking industry. Banks failed to prevent abuses from WorldCom by continuing to provide loans backed by credit default swaps. There was no risk in initiating or continuing business with these companies so why does it matter if they are responsible for faulty accounting practices, as long as you get your money. The way in which the banks supported these abusive companies is like betting one hundred dollars that someone who owes you one hundred dollars is not going to pay you. Either way you get your money back. Banks did not try and prevent companies such as WorldCom or Enron from continuing their schemes of IRU’s or riding revenue because they made the banks money whether they stayed in business or not. WorldCom’s scheme of classifying line costs as capital expenditures went unnoticed by the credit rating agencies that were hired to investigate. The credit rating agencies gave WorldCom an A- rating because they apparently did not spot the errors that WorldCom created. WorldCom was eventually downgraded but that was not until two months after the SEC had exposed the crimes committed in the financial statements. The credit rating agencies were lazy with their investigation and therefore let WorldCom continue their shifting of costs with an excellent credit rating. In the long-run, inefficiencies of the SEC, auditors, banks, and credit rating agencies only caused companies to continue unethical accounting and then eventually crash. They were either not doing a good enough job of prevention or chose not to prevent at all. These companies were going to be involved in accounting schemes with or without these different types of controls but they could have at least slowed them down or made it harder. This is not the true for all of these types of controls but in the case of this paper the SEC, auditors, credit rating agencies, and banks failed to prevent fraudulent accounting practices.…...

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