Accounting is the language in which one business can communicate with another. When the message is transparent, communications are conducted fluidly with both sides having the satisfaction of knowing that they are perceiving the whole picture. When accounting is opaque or managed, business goes into suspended animation until both sides fully understand the intent of the statements. In international business, when the two accounting systems are based on different theories, interpreters have to be hired to explain what the statements mean.

The accounting profession has evolved into an industry where transparency has given way to translucence and the once hoped for universality of accounting has slipped dramatically into the dust. For the most part, the auditing industry is cutthroat, with the competing firms desiring the business literally at almost any cost. This “win at any cost” philosophy brought with it moral concessions to management that destroyed a portion of the Big Eight Firms during the Savings and Loan Crisis and caused consolidations in most of those remaining. More recently, the Big Five have acquiesced to clients’ demands at the expense of transparency. However, the stakes have grown geometrically in the last decade. Both the accounting firms and their clients have globalized, and interdependency among professional firms and their clients and among businesses as a whole has grown. As a result, major economic sectors are vulnerable to the fallout of fraudulent accounting.

We are told that rudimentary accounting began six or seven thousand years ago in the Nile Valley of Egypt, The Pharaohs ran the equivalent of a very large conglomerate utilizing massive amounts of manpower. They had to keep track of progress and outlays. How many massive bricks of what size and in what order would they need to finish the next pyramid? What about the logistics of feeding, housing, and clothing the tens of thousands of workers that made up the construction crews. How much water would they need and when would it have to arrive before the men started to collapse in the desert heat? They developed a dual system of advanced logistics and a complex, highly organized system of accounting:

“The ancient dwellers in the Nile Valley first combined to organize the artificial irrigation their fields, a bailiff was appointed in every small village along the river to look after the irrigation canals. Each farmer had to pay him a certain quantity of grain and flax after every harvest. When the farmer had done so, a rude picture of a grain measure was drawn on the wall of his house, together with a number of lines indicating how many measures he had paid. This was the primitive form of receipt.” ([1])

Accounting could not really have its day of glory until several things came together; the first and most important was the invention of money, the ultimate accounting common denominator. In early history, man probably started out to trade with his neighbors by exchanging one item of perceived value for another of equal perceived value, such as a metal digging instrument for food. As time went on a change took place, because the person that desired a particular item may not have had something that the maker wanted in return. In addition, there may have been a perishable commodity involved in the transaction. Without Internet, which although many are unaware of it, did not exist in the years before Christ, two people that had items that they wanted to trade were more likely than not, unable to find a third party to close the transaction’s loop.

Thus, I have a digging utensil that you greatly desire; you only have food, which I have in abundance. Although unknown to both of us, Caveman Albert, just over the mountain needs the digging utensil desperately and has numerous seeds to grow highly valuable golum ([2]), which is in amazing demand around these parts. Sadly, our society of that era does not stretch over that particular mountain, while Albert and his family are able to gorge themselves on mountains of golum, much goes to waste as does the excess digging utensils and there is much hunger in the village on the other side of the mountain. Because golum does not store well and Albert’s cave family is without a digging utensil, the following season brings disaster to the mountains inhabitants and those below as well.

Money came into existence by necessity, and it took many forms from beads to cattle, but ultimately it happened that the easiest way of doing trade was with a currency that had an inherent value of its own, a gold or silver coin for example was perfect and it had intrinsic value, a critical element in gaining market acceptance for money. Precious metals were replaced by paper money backed up by these same metals with the exception that instead of residing in the buyer’s pocket they resided in a common place such as a government vault, a goldsmith’s shop or in someone’s vivid imagination.

Money came into existence by necessity, and it took many forms from beads to cattle, but ultimately it happened that the easiest way of doing trade was with a currency that had an inherent value of its own, a gold or silver coin for example was perfect and it had intrinsic value, a critical element in gaining market acceptance for money. Many say that in the sixth century BC, Croesus, who was the king of Lydian Empire was the first to refine precious metals into coinage. The Lydian’s were warriors and many historians of the time such as Aeschylus wrote much about all the gold stored in Sardis, the capital of the Lydian Kingdom. This was where the original saying about a truly rich man originated, “rich as Croesus” indicated fabled wealth even in those times.

The residents of Sardis were said to have panned for gold in the rivers that flowed near the city. This gold was mixed with silver and cooper and thus had to be refined. “…The Lydians placed the raw material in small bowl-shaped hearths in the ground and, fanning hot coals with bellows, heated it in combination with lead to remove the trace metals. Then the remaining material, mixed with common salt, was subjected to prolonged heating in earthenware vessels until the gold was completely separated from the silver.

As time moved on, these valuable metals were mandated to exist by government decree and resided in the particular country's central bank. ([3]) Moreover, it was usually stated within the currency that holders could exchange their paper for the more intrinsically valuable precious metals.

Many times throughout history, governments have attempted to mandate value for their paper money without proper backing, and as you could well have expected, those attempts have generally failed. On the other hand, they only failed because the people had no confidence in the continuity of the government and economically most important of all, that government’s ability to collect taxes. As anarchy started to reign as it did in post World War I Germany, the people lost all their confidence in the country’s money and in spite of everything that the government could do to stop its decline, the post World War I German currency probably lost more as a percentage of its value in a shorter period of time than any other currency in history ([4]).

Until the emergence of money, by adding row upon row of dissimilar items together, one could figure out what gross assets an entity had, but no clue existed as to what it was worth. There was no common denominator. In other words, if I had as assets, two fish, one cow and one mud hut and the bank wanted to know what my assets were I would write out a slip saying that I owned: two fish, one cow and one mud hut, and sign it. Until a translation into a common denominator occurred, accounting could only go so far. Many different denominators were used in various civilizations, but once trade extended beyond the boundaries of the country, those symbols meant little or nothing. Let us assume that the Indians had only wanted Wampum for the Island of Manhattan. Since wampum had no cachet in the Western World, Manhattan would still belong to the Indians. Luckily, for us, they liked jewelry, gold, and trinkets.

Goods were probably first translated to standard coinage sometime during the Greek ascendancy, although it was not until the late fourteenth century that anything approaching double entry bookkeeping came into being.

The first paper money was really a form of negotiable receipt. It came into being during the Middle Ages, most probably because highwaymen were robbing so many travelers that they were giving travel a bad name. Early monetary transfer systems were rather rudimentary in that the transaction really consisted of the traveler depositing his valuable coins with a goldsmith who in turn would issue a receipt. Because the goldsmith’s reputation was impeccable, the receipt was readily transferable among all of the people that were familiar with the goldsmith’s reputation and this became the earliest form of paper money. The early United States tried to create paper money by government decree with the Continental Congress issuing reams of it during the revolutionary war and giving it value by mandate. The war for independence was not going well so there were not a lot of believers around in those times and the new money laid an egg.

As inflation took hold of the fledgling American economy, the currency started to lose value. Many of the members of the Continental Congress thought that this could easily be taken care of by edict. And in January of 1776, “Resolved, therefore, that any person who shall hereafter be so lost to all virtue and regard for his country as to refuse said bill in payment, or obstruct or discourage the currency or circulation thereof shall be deemed, published and treated as an enemy in this country and precluded from all trade or intercourse with inhabitants of these Colonies.” I think it was a frustrated George Washington that once said during the Revolutionary War, “it takes a wagonload of Continental Currency to buy a wagonload of feed.” When the smoke had cleared, the paper money that the government had issued at what they said was 100 cents on the dollar had plummeted to 2 cents. The new American Government learned the hard way that there were certain critical basic elements missing in their idea, and the two most important were non-existent, confidence in the longevity of the government and its ability to collect taxes on an ongoing basis.

The next time the United States looked at paper money was during the Civil War. The story of its rebirth had an interesting beginning when Lincoln sent his advisors to meet with Salmon P. Chase, the then Secretary of the Treasury to convince him that the North should be issuing paper currency. Chase told them to advise Lincoln that paper money was illegal and could not be issued by the government because it was also unconstitutional and he would have no part of the scheme. Lincoln replied to Chase, “If you take care of the money in the Treasury, I will take care of the Constitution.

With the North and South beating up on each other, people still were reticent about buying into the concept but they did accept the issuance of paper currency by their local banks with which they dealt and had confidence. This in turn led to the start of a new business, the objective evaluation of banking soundness. Thus, several companies started rating the banks that were issuing currency and their ratings were to be based on ability of the financial institution to exchange their worthless paper money for silver or gold. Thus, certain money issued by weaker banks could only be exchanged at a discount and in some cases, money issued by large banks were worth a premium.

A rhyme was created in 1801 to better acquaint students with the rules of the double entry systems.

“By Journal Laws—What I receive

Is Debtor made to what I give;

Stock for my Debts must Debtor be,

And Credit my Property;

Profit and Loss Accounts are plain.

I debit Loss, and credit Gain.” ([5])

Therefore, when you did your books in the old days, life was much simpler. There were no weasel words like “materiality,” whose only purpose seems to be to hide critical financial information from innocent creditors or shareholders. Accounting has now become something similar to neurology, in that you have to figure out all of the possible pathways a company’s books can lead through, then bring in a forensic accountant and a number of consultants in order to even begin to understand what is going on with the financial reports.

John Law Screws Up

I am reminded about the story of John Law, who grew up in the early 17^th century. John was precocious as a youngster, showing early signs of being a mathematical genius by solving exceedingly complicated analytical problems that had been enigmas to even the most clever people of his day. He also possessed two other distinct disadvantages, he was extremely handsome and an inveterate gambler. However, as his successes substantially exceeded his failures in all of his many pursuits, his fame spread far and wide, and eventually he caught the eye of Louis XIV of France. Louis, as opposed to Law, was having a bad time of it. He really wanted all the better things in life, but not having enough money in his own treasury, thought to siphon some from his neighbor’s kingdom. Alas, this was an colossal mistake, it seems that he had not chosen his adversaries propitiously and he barely escaped with his life, and do to his blunder, went much further into debt. King Louis XIV did not earn the nickname molasses brains without good reason.

Louis was bummed out and when Law, always on top of his game, came up with a startling pronouncement, “We’ll start a Royal Bank, and I’ll run it.” Louis retorted looked at Law as though the man had lost his wits, “What good will that do, nobody in the kingdom has a franc, I have glommed on to everything that the people didn’t tack down. How can they possibly have anything left to deposit in your silly bank”?

Law was not unprepared, “Lou, you know all those stories about the New World, all that gold and stuff like that”? Louis indicated he was indeed familiar with those stories but further indicated that he had heard that opposed to precious metals, his intelligence had indicated that unfriendly savages and pestilence primarily inhabited the land. “Look at all those strange diseases the Spanish soldiers brought home,” he countered. Law was non-plused and continued, “We start a company and sell stock in it to the peasants. You know yourself that if we hire a top-notch public relations firm and give the deal the right amount of hype, we can make the commoners believe anything. We play down the bit about diseases and savages and tell them that the streets are made of gold in the New World and those chumps will fall for it and they will take what is left their money out of hiding. We take all of the money that comes from them, put it in the treasury and pay off all of your debt, and Louis, there may be even a little left for some of those bizarre little trinkets you really like, you know, the really weird stuff.” Louis thought for a moment and concluded, “John, I think that is a capital idea, we have nothing to lose and if it works, I will be indebted to you really big time.”

Well the idea worked. The money came in from unexpected places by the gobs and the government’s debts were paid, and there was even enough left for Louis purchase a few of his bizarre little trinkets and to throw a party or two for his friends in the court. But wait!

The peasants, having lost all of their money, now could not pay taxes. They were thrown out of work, and the country went into a depression far worse than when John Law had originally been given his assignment. Louis became disenchanted with his erstwhile friend, and the people harbored extremely grave ill feelings against the man. John Law, a brilliant conceptualist who just hadn’t thought his plan through to its inevitable conclusion,; was run out of town and died a pauper. The plan he devised became know as the “Mississippi Scheme”, which along with England’s “South Sea Bubble”, almost drove Europe back into the dark ages. Economic planning and a good accounting background would have told both the King and Law that their proposal was a lose-lose situation, but they didn’t have Big Five Accounting firms to rely on and plot their course then, did they? As we continue on you will see how the many new accounting innovations could have been taken advantage of and more importantly, if you ever have a kingdom of your own, you will be in an extremely advantageous position to take advantage of these tricks of the trade, so to speak.

The World In Which We Now Live

However, today, choices among the numerous potential accounting pathways are dictated by the nuances of international tax regulations, transfer pricing; derivative oriented profit and loss along with complex currency computations. On the other hand, that and a subway token will only get you a ride in underground New York. You still will have to understand the nuances of tax-oriented transactions, inventory restatements, auditor changes and a world of highly complex accounting trails that amazingly are not there for information purposes but to hide the real facts and thoroughly confuse investors. And after you have diligently studied the financial statements, it is highly likely that you will have come up with the wrong answer because accountants today, take some much leeway with the facts and are so good at inventing new characteristics, which are totally opaque and they are no longer interested in making the books comprehensible in any form whatsoever.

Life was never intended by our ancestors to be so complex and the role of the outside accountant has shifted dramatically to that of a corporate advocate, not an honest third party entrusted with protecting the public interest. The interests of businesses that are too big or too powerful to be governed by the regulators are driving the evolution and resultantly, the demise of accounting as a useful tool. Despite endless tough talk by the regulators, little has been done to make derivatives more transparent. Because of peculiar nuances with the accounting term “materiality,” massive potential ([6]) losses can be hidden over a period of years and shareholders can be totally deceived.

More businesses practice tax evasion today than at any time in American history and that undertaking has become so pervasive that the U. S. Government has used every weapon at their disposal to slow it down, with little or no result. Today’s public company’s bottom would cause Hammurabi to turn over in his grave. Adding to the problem is the fact that the number of students studying for a degree in accounting in American Universities has dropped almost a staggering fifty-percent in the last several years. Although, we are aware that other industries offer a lot more excitement and possibly substantially more remuneration as well, we are just forced to speculate whether the younger generation with their environmentally uncontaminated attitude have not determined that the accounting profession presents a contaminated cesspool that is so totally polluted from conflicts of interest and gimmickry that almost anything may represent a better alternative.

Hammurabi in his infinite wisdom had a fantastic solution for excessive creative accounting; if the books did not reflect accurately the person or company’s affairs, the instigator was summarily put to death. This, theory has followed us through history; in recent history, the penalty for attempting to defraud by keeping incorrect books has been a substantial amount jail time, unless of course your inventive accounting was used to fool the King when tax time rolled around. In that case, the King had several options available; accountants who fudged were either boiled in oil under a slow flame or stretched on a horrible contraption until they no longer fit into their clothes. The later is somewhat of a misnomer in that at that point whether the accountant could wear his clothes or not was no longer relevant; he would not be needing them. Thus, accounting quickly became cleansed of those with visions beyond the books that they were auditing and the profession developed a reputation for a degree of piousness.

Maybe we should go back to simpler times and look at the books in the same way the kings did. Life probably would become much easier and it certainly tends to keep the game more honest. As you read the following, I will leave it to your decision whether you think that accountants, who fudge the numbers, should be placed on a rack in the center of town where each citizen could take one turn at the wheel.

Theodore Hook made up the following little rhyme when talking about paying the correct amount of taxes:

‘Here comes Mr. Winter, collector of taxes.

I advise you to pay him whatever he axes:

Excuses won’t do; he stands no sort of flummery.

Though Winter his name is, his presence is summary.”

Edna, The Guy with The Green Eye Shade Is Dealing From The Bottom of The Deck

We know of no service industry that has had the kind of attrition that the accounting industry has recently succumbed too. It does not seem to matter whether times of good or bad, these firms are equally able to fail under varying economic conditions. You only have to look at the number of letters in the names of each of the Big Five to see where they have been and what they have gone through. The amount of money that their litigation has cost the insurance industry is legendary. And yet, knowing that the accountants will regularly get caught trying this maneuver or that tactic in order to separate the public from its hard earned dollars does not seem to matter. While settlements for class actions, claims against the accounting industry have literally rocketed out of sight, so to have the premiums that the insurance companies charge to insure their longevity. Obviously, the ultimate provider of the funds to pay for the insurance are the accounting clients and it almost seems that they are starting to charge on a risk reward basis and not by they hour.

Accounting firms engage in heated negotiations when major firms are in the market to replace auditors. Often they will indulge in substantial “opinion shopping ([7])”, and discuss in advance with potential clients how aggressive these accounting firms will be when reporting earnings, hiding loses, carrying over profits and managing earnings, should they get the account. The sad part of this bizarre mating process is that opinion shopping or in the alternative, the threat of it, more often than not causes the once sacrosanct “corporate books” to sink to their lowest procurable common denominator, sending the industry standards into moral freefall. The following legal cases are not meant to be indicative of the total number of times that major auditing firms have either fudged earnings or looked the other way when management has become overly creative in their sales or earnings reports. It restricts itself to only those situations in which plaintiffs felt that their interests were compromised and that the accountant’s work was so egregious to be worth noting in a court of law.

The accountants always had their best faces on when it came to facing the news people relative to their countless screw-ups and historically have mouthed such homilies such as “we have our defenses to the charges and will be vindicated by a court of law,” or better yet: “we have not seen the charges so we are in no position to comment at this time,” “The firm stands by its work which we believe follows GAAP principals to the letter.” Usually after this initial round of weasel talk is over and the case goes against the accounting firm, their management comes up with a new series of responses when found guilty of breaking the public trust: “our attorneys advise us that we have substantial defenses to the charges and that we should be vindicated on appeal” or when caught “red handed”, “this has been a case where one bad accountant has spoiled it for an entire firm whose reputation to this point has been impeccable” and when all else has failed, “the firm and its managing partners will suffer no substantial monetary damage due to the massive award against us as our insurance carrier is responsible for the entire amount, naturally less the deductible”. We can count the number of outright victories by the major accounting firms on the fingers of one hand, at least in the examples that we cite.

In addition, if anything, the situation has gotten far worse as it appears that the U.S. Treasury is close to losing control entirely over both consistency and transparency in tax reporting. Significant American corporations and their accountants now visualize tax avoidance as an integral part of doing business in today’s globalized economy. Among other wondrous creations has become the formation of endless offshore insurance captives where money can be stashed for rainy days or can earn substantial additional dollars tax-free while providing insurance or reinsurance is ubiquitous. The countries in which these captives are based usually have accounting regulations that were created with the maximum tax latitude as a criteria. After all, the industry of tax avoidance may be that countries largest source of hard-dollars.

In a global economy, transfer pricing ([8]) is a critical strategy in insuring that taxes are paid to the most favorable domicile. Although transfer pricing is more of a daisy chain then offshore insurance captives, they are both equally effective in keeping money off of the tax rolls. Simply put, as the product moves through its various stages from gathering the raw materials to creating the end product, there are places where labor is cheap and places where taxes are low. Sometimes you can even find places where labor is cheap and taxes are low in the same country. These countries are usually called dictatorships and substantial rewards are usually bestowed on those in power in order to receive these munificent benefits. If a company is looking to save money on its tax bill, it will create its greatest profit where taxes are the smallest or perhaps non-existent, for the right price.

Monolithic international mega-mergers have become as normal as brushing your teeth in the morning, yet the European Community (EU), also sets up critical barriers that must be addressed when analyzing corporate strategy. How incredible it was to see the EU’s Monopoly Commission threaten to literally kill the proposed merger between two American Companies, Boeing, and McDonald Douglas. At first glance, it was the consensus that Boeing would tell the EU to stick it, but when faced with their planes not being allowed to land at European airports, carry European travelers or be purchased by EU countries the mood suddenly changed. Boeing blinked, and made serious concessions to the EU in order to get their blessing.

This is not exactly the point thought, the EU, however, had their own agenda, a competing plane built by Airbus and instead of the free trade envisioned by the World Trade Organization, (WTO), it would almost appear that among those that argued the strongest for bringing down the barriers, protectionism has come back to haunt us with a vengeance. All that has happened is the that large global villages have been created by organizations such the European Community, The Nafta Signatories, the ASEAN countries and the emerging Latin American Block.

Moreover, that is not to mention the fact that the “International Oil Cartel” which crosses all boundaries in their effort to act in restraint of trade and impoverish their benefactors. Why doesn’t the all-powerful EU attempt to place a food embargo on these countries in those arid regions where oil seems to come from deserts in enormous quantities and is regularly withheld by what is literally a criminal cartel of thugs. But, in their wisdom, the EU would rather chose to fight a far lessor battle then address the real needs of their constituents. We have indeed entered a strange new world where the inhabitants are like characters out of Alice in Wonderland. Morals have become a function of politics and economic battles are fought in the press, and not be governments. The battlefield is chosen relative to the chance of success, not the worthiness of the cause.

Another anomaly of our “New Age Accounting Based Economy” is the fact that in the last two years, a period in which the stock market climbed to unprecedented heights, unbelievably, corporate tax payments declined. However, during this same period, these same corporations publicly reported that their earnings dramatically increased. Talk about “Alice in Wonderland”. One has only to look at the outlandish accounting statements emanating from companies such as AOL, Cendant, Livent, and Waste Management and their high priced magical making accountants to wonder whether the world really hasn’t turn upside down and the Mad Hatter isn’t running things. Motorola, Compaq Computer, and WorldCom have all taken eye catching, one-time charges of astronomical proportions. Hammurabi and the king would have stretched new suits for all of these folks.

Outright fraud, over-aggressive accounting, and misleading numbers have taken away the time honored practice of requiring that corporate statements reflect how well the company has performed during a particular accounting period, when comparing that period with another one. No longer is this achievable because the accounting processes used to determine earnings and even sales may be totally inconsistent from period to period ([9]). More exasperating is the effect of companies changing accountants midstream when the current auditor will rightfully not allow a deduction or balance sheet item that another equal prestigious accountant thinks is acceptable. Obviously, when this occurs there is also a change in methodology and yet when looking at the footnotes, you cannot tell where one accounting firm has begun and another had ended. This is truly amazing and obviously has the tendency of making the accounting profession one of not only selling its sole to the highest bidder but dropping off a precipice and falling until it has reached the lowest possible common denominator. ([10])

Front-loading expenses and taking the “big bath” all at once are tricks that permit corporate earnings management; something that has concerned the Securities and Exchange Commission no end. The SEC’s chief accountant, Lynn Turner, in a meeting with officials of Big Five Accounting firms among others, states; “If the basic accounting foundation ever loses credibility with investors, then the whole process would fall apart.” Arthur Levitt Jr., in a speech delivered on September 28, 1998 sounded like he was talking a foreign language when he addressed these issues, which included, “Big Bath Charges,” “Creative Acquisition Accounting,” “Cookie Jar Reserves,” Materiality and “Revenue Recognition”.

It is critically apparent that the accounting profession discovered little or nothing from their near-criminal and criminal behavior in auditing the Savings and Loan industry. Recently, Big Five Accounting Firms have routinely started recommended extremely aggressive tax shelter positions for their clients. Creative new tax shelters are cropping up all over the place and have had such a huge impact on tax collections that the IRS has signaled its intention to scrutinize these ploys very closely. Henceforth, the IRS states, it will not only refuse to allow any deductions without a reasonable business purpose, but, in a deadly one-two punch, it will also require disclosure of the names of all tax shelter clients of the accounting firm. Not satisfied that these two solid ideas have done the job, the Administration has stated that they will put more IRS agents into the field to ferret out corporate cheating. Between managed earnings and sheltered income; transparency, as defined by GAAP, the SEC, The World Bank, The U.S. Treasury, the IMF, the United Nations, and the Bank for International Settlements and a host of other do gooders, has become a mirage. ([11]) Transparency can now be defined as a process that can only be foisted on underdeveloped countries and small public companies with limited resources. It is readily apparent that we are arriving at the never-never land of tax anarchy for the big and powerful. Thus, the meek and sickly will be forced to take on more of the burden in the years ahead if there isn’t a rude awakening.

When the time comes, and it has, that earnings can go through the roof while tax collections decline, financial reporting has obviously reached a new level of sophistication. Corporations have become mobile beyond comprehension. Chief Executive Officers (CEOs) are now able to maintain control over their divisions from almost any point on the planet. Of the 200 largest economies in the world, at least 100 are corporations. Because of the universalism of the Internet and globalization of manufacturing, the catch phrases “Made in the USA” ([12]) or “An American Corporation” have literally lost all of their meaning. Today you need a scorecard just to figure out where a company is really domiciled and even when you have pinpointed what you think may be correct, you will find that their portability is infinite. Their offices are in the corporate jet in which the CEO travels. Moreover, what does made in American mean anyway? Manufacturers have been avoiding a foreign label by having the buttons put on shirts made in Hong Kong in the American possession of Guam since the end of World War II. What you see has never been further from what you get in history. When the American Government determined that the term “Made in America” had become a total myth, the unions banded together and forced the Federal Trade Commission to reconsider its proposed changes. Once again, Alice and her friends prevailed over reality, and local interest groups have snatched truth out of regulation. Thus, we continue to live a sham.

Clients, especially dot.com companies, tell their accountants that aggressive tax accounting is critical to their global survival. Yet, the rules with regard to transparency and fraud have tightened. Moreover, the stock market has always been a wonderful equalizer, you can only blow smoke for so long but ultimately you will have to deliver. If that delivery day does not arrive within a reasonable interval, the stock market and then the public will severely punish both you and your accounting firm. Once again, the accounting industry is being set up for a fall but this fall will be even worse than the last.

Unprecedented numbers of reasonably capitalized companies will fail because of an number of factors: mis-guessing technological changes, not having the funds to keep up with competition, inexperienced management who were idea rich and delivery poor along with sudden unforeseen shifts in technology. Companies such as Amazon and Priceline who have promised much and delivered little will eventually cause their accounting firms severe financial indigestion when disgusted investors look for scapegoat. The simple consequence of being wrong in any of these areas has always been extremely severe. Jail time, corporate bankruptcy and lawsuits against accounting firms are a few of the tools available to an angry public and the class-action attorneys that are always circling the playing field like a vulture looking for carrion. The stock market is an economic “grim reaper” ultimately separating the wheat from the chaff; as high-tech anomalies that demanded unusual accounting treatment fall by the wayside, so will the accountants. Instead of the Big Five, we may soon be looking at the Big Zero and the day of the honest outside accountant dedicated to protecting the “public interest” will go the way of the Dodo Bird and the Wholly Mammoth.

Accountants are now looking for new ways to increase revenues: they have sought changes in the anti-rebate regulations of the American Bar Association and have acquired law firms, investment bankers, consulting firms in almost every industry. By dealing through their “independent” consulting arms, they have even learned to take stock in promising companies. By having their consulting arms in separate corporations, the accounting firms feel they have avoided some degree of legal risk, but in our world of expo facto justice, this will hardly win the day. The Mad Hatter and the Queen of Hearts set Alice straight, but who will send the accountants the message, “you will be the fall guys, one more time.” Or perhaps there is method in this insanity, ensconced management is only in it to take the money and run, live the good life and not worry about their junior partners who will take the brunt of today’s excesses.

The “Big Five” accounting firms have not acquitted themselves with flying colors when it comes to protecting the public interest. Both the public and private sector have prosecuted them all for incompetence, fraud, and theft. To give you some idea of how well the major accounting firms have protected the public trust and avoided conflicts of interest, we have listed below, a short synopsis of a selected list of fairly recent litigation. The list shows the names of the accounting firms, who they were auditing and what went wrong. Moreover, most of these cases ended up in court or with people going to jail. We have tried to synopsize these shortcomings in the auditor’s work. We have concentrated for the most part on public companies and Big Five auditing firms. The material that we have listed below comes from numerous other sources.

With their track record, the accounting firms should be more prescient. In simpler times, when accounting was tamer than it is now, these scandals occurred:

The Big Guys Went Wrong

Laventhal and Horwath,

· Went out of business rather than fight over $2 billion in litigation regarding their work product. Primarily caused by the Savings and Loan problem.

Ernst & Young.

Filed misleading audits of Republic Bank of Dallas, Texas. SEC filed charges in a complaint.
Settled with litigants for $335 million, one of the largest cases in accounting history; Cendant Corporation and the fat lady hasn’t stopped singing yet.

· BCCI, Accountants were sued by investors and regulators for $1.6 billion for there actions in covering up the bank’s fraudulent activities.

Part of Lincoln Savings and Loan. (Arthur Young).
In one of the great votes of confidence of all time, The General Accounting Office of the United States Government stated that Arthur Young’s audits of the Savings and Loan Industry, “did not meet professional standards.”
In November 1992, Ernst and Young agreed to pay $400 million in settlement of misleading regulators regarding the financial health of miscellaneous thrifts.
Resolution Trust Company as Conservator for Imperial Savings sued Ernst and Whinney for $26 million.
Ernst & Whinney was sued by the Federal Deposit Insurance Company concerning their audit of City and County Bank of Anderson Tennessee for $255 million. CIV-3-87-364
Ernst & Whinney was sued by the Federal Deposit Insurance Company regarding their audit of City & County Bank of Knox County. CIV-3-87-364 for $255 million. (See above)
Ernst & Whinney was sued by the Federal Deposit Insurance Company for their audit of First Peoples Bank of Washington County Tennessee.CIV-3-87-364 fir $255 million. (See above.)
Ernst & Whinney was sued by Federal Deposit Insurance Company for $255 million because of their audit of United American Bank of Knoxville, Tennessee. CIV-3-87-364 (see above)
The Federal Deposit Insurance Company sued Ernst & Young for $560 million concerning their audit of Western Savings Association.
Merry-Go-Round, Ernst & Young provided consulting services for the company and was charged by the Trustee in Bankruptcy of incompetence, fraud, and misrepresentation. Ernst & Young settled the matter for a stunning $185 million after being sued for an even more stunning $4 billion. This case had more conflicts of interest imbedded in it that probably any other accounting matter in history.
The General Accounting Office of the United States Government stated that Ernst & Whinny’s audits in the Savings and Loan Industry, “did not meet professional standards.”
Stockholder derivative actions were filled against Ernest & Whinney for tens of millions of dollars for failure to use even a modicum of due diligence in the amazing case of ZZZZ Best. This is an instance of a prepubescent child taking on one of the top accounting firms in the world and making them like utter fools.

Arthur Andersen,

Settled with investors regarding their accounting in the demise of Lincoln Savings & Loan for $30 million.
Settled with Federal Government for their errant accounting in the case of Lincoln Savings & Loan, approximately $25 million.
In July 1993, Arthur Andersen agreed to pay $79 million in the case of Lincoln and five other thrift oriented lawsuits.
DeLorean Motors, Arthur Andersen paid big bucks to settle with Trustee for inept accounting in motor deal gone bad in which drugs paid a critical role. Arthur Andersen was so awed by DeLorean that they couldn’t see either the conflicts of interest that he had created or the fact that their numbers we inaccurate.
Sunbeam, Company was guilty of fudging literally all of their numbers under the guidance of turnaround expert, Chainsaw Al Duggan. Duggan got rich while thousands of loyal employees got fired. Andersen did his bidding and when the smoke had cleared, they were totally taken in by Duggan homilies.
Waste Management, One of the biggest restatements of earnings in financial history because literally everything the company reported was fudged. Once again, Andersen ultimately paid a dear price.
HBOC, McKesson, Bought HBOC on strength of the their growth which was none existent. Almost everything about this company was a fraud and the accountants missed it. The shareholder’s derivative actions are immense and there is little way for Andersen to escape major claims
E. F. Hutton, Arthur Andersen made no bones about the fact that they were aware of a massive check kitting and money laundering operation going on at Hutton. They even warned the firm, but did not qualify their statements, report the mater to the authorities or resign. If ever there was a case of an accident just waiting to happen, this was it.

Deloitte & Touche,

Charged with fraud and negligence in audit of Executive Life Insurance Company.
Part of Lincoln Savings and Loan action. (Touche Ross)
Federal Deposit Insurance Company (FDIC) sued Deloitte & Touché for $400 million regarding their audit of First South, FA.
Resolution Trust Company sued Deloitte Haskins & Sells for their conduct in auditing Royal Palm Federal Savings & Loan for an undetermined amount.
Sued by Federal Savings & Loan Insurance Corporation (FSLIC) for $300 million over their audit of Beverly Hill Savings and Loan.
Sued by Resolution Trust as Conservator for Aspen Saving Bank regarding the audit of Commonwealth Federal Saving and Loan for $50 million.
Deloitte Haskins & Sells was sued by Resolution Trust Company regarding their audit of Peoples Federal of Oklahoma for $467,000
General Accounting Office of the U.S. Government made an example of them when they stated that their audits of Savings and Loans “did not meet professional standards.”
Livent shareholders have united to file a class action lawsuit against the company's auditors, Deloitte & Touche in Canada, and co-founders Garth Drabinsky and Myron Gottlieb. Suits have been filed against Deloitte for tens of millions of dollars. The auditors in this one seemed to have missed the fact that there were truly two sets of books.
Philip Services, a situation in which the SEC has accused Deloitte of almost filing no audit at all. To see how bad accounting can get, this deserves a look.
Deloitte & Touche settled along with Coopers for over $50 million to the administrator of Barings, for failure to weed out financial irregularities in the books of that company.
Cendant, This Company was one of the great accounting frauds of all time and the auditor’s, Deloitte Touche were ordered to repay over $300 million, a record to that point. Almost from the day of inception, there was not a lot that was real about this company.
Koger Properties, A jury found that Deloitte Touche aided in cooking the books of this company. They found against the company to the tune of $81 million. This was appealed twice and Deloitte won the third round in a question of causation. Plaintiffs are taking the matter to a higher court. The SEC sanctioned Deloitte’s auditor on the account because he was a shareholder of Koger and thus not truly independent. We have seen numerous instances of accountants holding stocks in companies that they are auditing and are totally mystified by the process. In one case, the Chairman of the Board of the accounting firm was a stockholder.

KPMG Peat Marwick

Resolution Trust Corporation sued for $100 million regarding misleading audits of Hill Financial Savings Association.
Sued by Resolution Trust as Conservator for audit of Duvall Federal Savings and Loan for $16.6 million.
BarChris Construction Company, a senior auditor, not a CPA, 30 years old and in charge of his first audit was asked to do the accounting of a company that built bowling alleys. He failed miserably in uncovering a fraud and Peat Marwick was found with others to be guilty of negligence in the classical case of its kind.
Crazy Eddie, Probably the classic fraud of the 1980s where the accountants, Peat Marwick made every mistake that was possible. Settlements with shareholders were substantial and Crazy Eddie is still in jail. Inventory was going out the backdoor faster than the accountants could keep track of it.
Wedtech, This Company rounds out the list of classical companies that Peat Marwick represented. They probably shot the new business partner after this one. This case undoubtedly set the all time record for politicians associated with a company going to jail. Once again, shareholders sued and collected substantial monies from the accountants for their auditing miscues.
Yale Express, While you can make a fairly good case that what Peat Marwick lacked in quantity it made up in quality. The BarChris, Crazy Eddie, Wedtech, and Yale Express cases are absolute classics in how not to do accounting. In Yale Express, Peat Marwick although warned several times would not force the company to make necessary adjustments in the financial statements to make them truly reflect the business conditions as existed. Because Peat Marwick never followed up, it was sued for its non-actions and ultimately settled for an undisclosed sum of money.

Price Waterhouse, Coopers

English lawsuit in the amount of $3.5 billion regarding their audit of BCCI.
Coopers and Lybrand charged by Phar-Mor for compensatory and punitive damages: Phar-Mor demanded that the accounting firm be held liable for civil actions filed against the chain.
Coopers and Lybrand was fined over $1 million and assessed costs of over twice that much for accounting errors in the Robert Maxwell fiasco, in which hundreds of millions of dollars were lost. Worst of all, Maxwell was using the employee’s profit sharing and retirement funds as his private piggy bank.
Coopers and Lybrand was accused of conspiring to overstate MiniScribe’s financial health to the bondholders. (Settled with bond holders for $40 million)
Conspired to overstate MiniScribe’s financial health to the stockholders. (Settled, amount unknown.)
ZZZZ Best, Took over the accounting of this sham company without kicking the tires causing massive stock market losses for investors. Involved in class action. A classic instance where one accounting firm has had enough and another blithely marches in without asking the right questions.
Silverado, Coopers agreed to pay the Federal Deposit Insurance Corp. $20 million over three years. Things probably would have been a lot worse if wasn’t for the fact that one of George Bush’s sons was a director. It may be that Coopers got off easy.
Guarantee Security Life Insurance Co., of Jacksonville, Florida, Coopers was charged with breach of fiduciary duty, negligence and breach of contract by Florida Regulators in a $300 million action.
Cal Micro, A situation so egregious that the SEC in an unprecedented announcement stated that they would try to ban Coopers from ever again signing off on a public audit. Obviously this was worked out behind the scenes but we are unaware of any other instance when the Securities and Exchange Commission became so enraged over a public audit.
Kurzweil Applied Intelligence, Coopers & Lybrand did the audit during the period when the company was going public. It was later announced that sales had been inflated by approximately 40%, which Coopers obviously had missed. When they ultimately caught the fraud, investors had already invested in the company and lost everything when the stock collapsed.
Barings settled with administrator along with Deloitte Touché, the predecessor accountant for Barings, for over $50 million for failure to catch financial misdoings in 1992 by Leeson.
Towers Financial, $450 million lost by investors with the principal claiming that he was aided in his fraud by Price Waterhouse, Barbados. While we don’t give any credence to the fact that Price Waterhouse aided in this blatant fraud, there is no question that a lot got by them in their audit responsibilities.
Emcore charged Price Waterhouse, Coopers and senior employees of Racketeering. SEC censures PricewaterhouseCoopers for not complying with the standards of independence. 1998. Once again we have an instance of the accounting firm creating their own conflict of interest.
Fidelity, Securities and Exchange Commission censures Pricewaterhouse- Coopers with not complying with the regulations covering auditor-independence. It seems that PricewaterhouseCoopers and Company had a lot of problems with keeping track of what companies their auditors owned stock in and thus, created a series of mistakes that could have easily been avoided.

TYCO, PricewaterhouseCoopers guilty of allowing some of the most innovative and aggressive accounting seen on this planet to that date. Case has set standard for how not to do books unless of course you want to have big time IRS and shareholder problems.
Robert Maxwell, Drained the pension fund right in front of the accountant’s noses. Used money to support lifestyle and acquisitions.
America’s Future, Charity headed by General Colin Powell used PricewaterhouseCoopers data that was both unchecked and incorrect to push phony charity claims. Pricewaterhouse acted in almost a disgraceful manner when they claimed that it wasn’t their fault because although they authored and issued the misleading report, they hadn’t conducted an audit. Sounds to me as though their public relations department should have left well enough alone.
W. R. Grace, Pricewaterhouse aided Grace in managing their earnings illegally and hiding the rise in compensation of retiring CEO.
Symington, Coopers & Lybrand, climbed aboard Arizona political machine in representing the governor, phonied up his books in exchange for political business. Also took care of incorrect fillings in his real estate company, which went under. Ex-Governor is now in jail and will be for foreseeable future.
Old Republic, PricewaterhouseCoopers allowed Old Republic through their strange sense of morality to literally steal the money belonging to their clients from an escrow fund. This was one of the most substantial breaches of the public trust that we have seen to date.
Coopers & Lybrand, were auditors for Phar-Mor, Giant Eagle, and Tamco. All three were literally owned by the same person who appears to have been swindled along with investors and creditors in one of the largest private companies ever to go under in the history of the United States. Estimates of the fraud vary from $500 million to $1 Billion. Coopers settled with creditors for a substantial payment. Coopers fell for one of the oldest inventory deceptions in the book on this one by not creating a large enough sampling and going back on their work.

“Phar-Mor, Leslie Fay, ZZZZ Best, Kendall Square Research, Crazy Eddie, Mini-Scribe, Kurzweil Applied Intelligence, New Era, the savings and loan crisis and First Executive. The list of notorious financial frauds and scandals in recent years goes on and on. And in each instance, angry investors and an incredulous public were left wondering: Where were the auditors? In most of the instances above, they were totally out to lunch. Any of the above frauds could have been easily uncovered by a motivated accounting student with a degree of paranoia in his soul. The deceptions were shallow to say the least and the fact that shareholders lost billions because of bumbling accountants is a crying shame.

However, for the auditors, that has proven to be a mighty expensive question. In the wake of those and other scandals; lawsuits against the green-eye shaded types have soared to a point of unbelievability. Burned investors – who along with government regulators in the Savings & Loan debacle – argued that accountants who did little to unearth questionable practices and thus, determined that they were just as liable as the corporate execs in actually misrepresenting the numbers. Moreover, plaintiffs won in court much more often than not. Accounting firms have spent upwards of $1 billion to settle civil lawsuits since the early 1990s.” ([13]) In addition, it has been estimated that the Big Five have spent over $400 million per year since 1990 just on litigation costs.

I Understand It Now, But Who Pays An Accountant To Be Independent?

In theory, the outside accountant provides a set of checks and balances on a public company in their financial communications with the public. Also relying on the independence of the outside auditor are regulators such as the Securities and Exchange Commission, which has a requirement that a public company has an independent outside accountant. Other regulators are also dependent on their reports such as the Self Regulator Organizations (SROs). Primarily, these are the stock exchanges and the National Association of Securities Dealers (NASD) who have regulatory status. Listing requirements vary from exchange to exchange, but a substantial negative change in a company’s outlook can get their listing removed. When they receive a warning (which they will) that such an action is in the works, it sends a strong message to shareholders to watch out. On the other hand, if the independent auditor is not doing his job, the message does not get sent and the public and the exchange are none the wiser until the bottom drops out and pandemonium rules the day.

On the other hand, we know what everyone thinks of squealers. These are not necessarily great people and usually they are willing to tell all about someone because something is in it for them. With the independent accountant, things are very different. If they tattled to the SEC every time that one of the companies that they audit does a no no, two things will become inevitable. First and foremost, they will probably loss that client, and secondarily and even more import, they will probably never get another client as long as they are in business. Yet the SEC has instilled them with them with the fact that they must be truly independent, which is impossible for the reasons above and the fact that they must follow the letter of the law when doing an audit. Although this is wonderful in theory, in practice, each company has its own vagaries. The risk of calling in the marshals on your own audit client can be just as bad in many instances as not doing it.

Thus, the accounting industry as practiced under existing regulations is about as logical as an old shoe. There just ain’t any winning in it for anyone. Moreover, it only has become a matter of how much you, the accountant, are going to lose and whether or not it can be made controllable through insurance and other insulating devices. One thing is for sure, this isn’t a business for the faint of heart. Imaging how long you would last if you were to be known to be in the business of ratting on your own clients, which is exactly what is expected by the regulators. The auditors fight tooth and nail over potential clients; this courtship itself creates an aura of mutual dependency that, in spite regulation, flies in the face of becoming a stoolie. But this isn’t a story that concerns itself with how hard it is for accounting firms to operate in this kind of regulated environment, the fact that it is tough is a given, however, this is a story of many accounting firms that went to far overboard under any set of circumstances in their efforts to keep a client alive. We are talking about those that went beyond both logic and the law and that seems to cover the accounting spectrum, at least on the high end.

Moreover, an accounting firm that consistently turned in its own customers to regulators would find that new clients were, kind of shying away from them with good reason. Historically, the rules require that an accountant take a neutral position toward his client, auditing the books as though he was working for an anonymous third party. In the real world, this assumption makes about as much sense as catfish jumping into a hot frying pan. However recently, the price of admission has been raised, requiring a more jaundice yardstick to be used when analyzing a client’s books. In the meantime, the public and private sectors have both paid a horrendous price for accounting firms’ lack of true independence, as well as their stupidity, laziness and lax standards.

Despite the regulators’ tough talk, the reality is that accounting standards have been lowered substantially and laxity regulating the dot.coms have taken accounting creativity to a new level which has now overflowed into non Internet companies. Either the SEC has grown unwilling to enforce the rules of the game or they have changed those rules dramatically to give some breathing room to Internet oriented technology companies to reach puberty. Ultimately, the public will be rewarded for this mistake on the part of regulators by paying a price even in excess of that which was the tab when the Savings and Loans went down. On the other hand, once the accountants for the dot.coms invent a new method of making their balance sheet unreadable, companies that are normally considered to be in the main stream, pick up the cudgel and join the party. Hell, if those guys can do it, why can’t we?

It appears that the public rather than the regulators ultimately creates a level playing field by filing litigation when earnings become inflated due to enchanted accounting. When investors lose money, everyone pays for the indiscretions. Litigation will increase in geometric proportion to the fall in technology stock prices and margin calls. We will soon be faced with the old boulder going down the hill scenario; the faster it goes, the more velocity it picks up, and eventually the only thing that can cause it to stop is its loss of dynamics. It has lost its pent-up kinetic energy. These lawsuits could well exacerbate market declines to the point where the process may spiral out of control.

In order to prove our point we will give numerous examples of how auditors closed their eyes to accounting misdeeds in order to maintain a client relationship. The SEC regulations state that outside accounting firms should take the position that their client is neither honest nor dishonest and treat the books accordingly. This is usually translated as: if the accountant suspects something amiss, the trail must be followed until the doubt is put to rest.

Sadly for the public, this rule is not followed about as often as an Atheist goes to church. Accounting firms have turned themselves into pretzels to accommodate the bizarre activities of some their clients. Again and again, the major accounting firms have proved that they are not really independent when it comes to auditing their own clients’ books. They have looked the other way consistently even in instances when they have been put on notice that something may well be amiss. In addition, often when an accounting firms resigns because it has serious doubts about its client, little or no checking is done by the new firm as to the motivation behind such resignation. Moreover, it is has been literally a game of musical chairs within the industry that when one accounting firms leaves, without letting the seat get cold, a new auditor “assumes the position”. Think of this; can you ever remember a situation no matter how bad the company that they were unable to get an auditor to do their books.

In many cases, no checks are made to confirm that sales booked have even been made. While costs can be fairly well established, when they are spread over fraudulent sales, earnings skyrocket because there is literally no charge against them.

The Banks Gone Bad

BCCI, Now Watch The Little Pea And Put Your Money On The Table.

“The Bank of Credit and Commerce International, S. A. (BCCI) story is important not just because a lot of people stole billions of dollars but because they got away with it right under the noses of the authorities and none of these watchdogs barked….This is a story of the breakdown of our institutions.” Larry Gurwin, Senior Investigator, The Investigative Group, Inc.

The bank was formed by Agha Hasan Abedi whose United Bank Ltd was nationalized in Pakistan by then President Zulfikar Ali Bhutto. Abedi was a good friend of Sheik Zayed bin Sultan al-Nahayan, a highly pro-Arab billionaire from Abu Dhabi. They were joined with Bank of American as the original investors in BCCI. The total capital of the bank was $10 million with the American Bank being by far the smallest investor. It didn’t take Bank of America long to see that the financial institution was not going in any direction that they would be contented with and they pulled out, stating that they did not trust various elements of the transaction. The Bank of Credit and Commerce International was chartered in Luxembourg and opened their doors there in 1972. Within a short time, they had opened five additional offices in The United Arab Emirates, Britain, and Lebanon. The bank probably grew faster than any previous similar enterprise in world history. Three years later, it had almost 150 branches in over 30 countries.

The bank was set up very shrewdly with the regulators in mind. It was everywhere and then again, it did not seem to rest anywhere. No major country with strict banking regulations seemed to want to call it their own, so no one did and the bank was allowed to move wherever and whenever it wanted to with no one checking its business or its capital. Robert Morgenthau put the matter succinctly when he indicted the bank in 1991:

“The corporate structure of BCCI was set up to evade international and national banking laws so that its corrupt practices would be unsupervised and remain undiscovered, this indictment spells out the largest bank fraud in world financial history”

The people that headed the bank were well versed in the game of bribery and were able to buy their way into Central Bank deposits from such countries as Barbados, Belize, Morocco, Panama and Jamaica as well as a host of others.

BCCI was even-handed in its operations. It dealt at the senior levels only in crimes of the first magnitude: drugs and illegal military shipments from Peru and Columbia, and money laundering in Panama. It was at the forefront in the financing of terrorism throughout the world, including Hungary, East Germany, Czechoslovakia, Yugoslavia, North Korea, and Cuba, while gaining substantial expertise in counterfeiting numerous types of documents. BCCI funded atomic weapons thefts and the purchase of unconventional weapons for radical Arab regimes. They became skilled at the creation of false end certificates, the nuances of bribery and the art of covering-up kickbacks. The bank became embroiled in countless murder investigations while serving as a front for political extremists throughout the Middle East. Moreover, they still had time to involve themselves as a substantial investor in CenTrust, a victim of the Savings and Loan fiasco, which cost American taxpayers over $2 billion. BCCI was even an important cog in siphoning $4 billion in U. S. Agricultural funds into Iraq, which indirectly aided Saddam Hussein’s war buildup. ([14])

Of all of the disturbing elements to arise from the ever-unfolding BCCI drama was the use of BCCI’s private airplane by the Secretary-General of the United Nations while on official business. When any entity provides amenities to heads of supposedly independent representative organizations, it shows a total lack of regulation and discipline on the part of those organizations. Ex-U. S. President Jimmy Carter’s introduction of BCCI to most of Asia was reprehensible; however, he was not representing his country when it was done.

Other Americans were also highly involved with BCCI, Bert Lance had $3.5 million in his debts paid off by the bank with a loan. Andrew Young while in office was a paid consultant to BCCI and Jesse Jackson received numerous favors. Among the rest of BCCI’s American help mates were former Secretary of Defense, Clark Clifford, former Senators and Congressmen, John Culver, Mike Barnes), former federal prosecutors, Larry Wechsler, Raymond Banoun and Larry Barcella, Former State Department Official, William Rogers, former White House aide, Ed Rogers and James Lake, former Federal Reserve Attorneys, Barldwin Tuttle, Jerry Hawke and Michael Bradfield. With that kind of ammunition you can certainly get your share of mileage.

Many people consider BCCI the greatest business scandal in history. Years later, lawsuits by the bank’s liquidators against the accounting firm of Price Waterhouse continue. Price Waterhouse is being sued for $3.5 billion and Ernst and Young for $1.6 billion. The complaints allege that they are partially responsible for losses by thousands of depositors. Even the Bank of England, which was the regulator for BCCI British-based operations, has been hit with suits totaling $898 million.

We can do no more justice than print an excerpt from the report issued to the Committee on Foreign Relations of the United States Senate by Senators John Kerry and Senator Hank Brown, in December of 1992. We are paraphrasing the report and to some degree changing its order:

BCCI's unique criminal structure -- an elaborate corporate spider-web with BCCI's founder, Agha Hasan Abedi and his assistant, Swaleh Naqvi, in the middle -- was an essential component of its spectacular growth, and a guarantee of its eventual collapse. The structure was conceived by Abedi and managed by Naqvi for the specific purpose of evading regulation or control by governments. It functioned to frustrate the full understanding of BCCI's operations by anyone.

Unlike any ordinary bank, BCCI was from its earliest days made up of multiplying layers of entities, related to one another through an impenetrable series of holding companies, affiliates, subsidiaries, banks-within-banks, insider dealings and nominee relationships. By fracturing corporate structure, record keeping, regulatory review, and audits, the complex BCCI family of entities created by Abedi was able to evade ordinary legal restrictions on the movement of capital and goods as a matter of daily practice and routine. In creating BCCI as a vehicle fundamentally free of government control, Abedi developed in BCCI an ideal mechanism for facilitating illicit activity by others, including such activity by officials of many of the governments whose laws BCCI was breaking.

BCCI's criminality included fraud by BCCI and BCCI customers involving billions of dollars; money laundering in Europe, Africa, Asia, and the Americas; BCCI's bribery of officials in most of those locations; support of terrorism, arms trafficking, and the sale of nuclear technologies; management of prostitution; the commission and facilitation of income tax evasion, smuggling, and illegal immigration; illicit purchases of banks and real estate; and a panoply of financial crimes limited only by the imagination of its officers and customers.

Among BCCI's principal mechanisms for committing crimes were its use of shell corporations and bank confidentiality and secrecy havens; layering of its corporate structure; its use of front-men and nominees, guarantees and buy-back arrangements; back-to-back financial documentation among BCCI controlled entities, kick-backs and bribes, the intimidation of witnesses, and the retention of well-placed insiders to discourage governmental action.

“BCCI systematically relied on relationships with, and as necessary, payments to, prominent political figures in most of the 73 countries in which BCCI operated. BCCI records and testimony from former BCCI officials together document BCCI's systematic securing of Central Bank deposits of Third World countries; its provision of favors to political figures; and its reliance on those figures to provide BCCI itself with favors in times of need.

These relationships were systematically turned to BCCI's use to generate cash needed to prop up its books. BCCI would obtain an important figure's agreement to give BCCI deposits from a country's Central Bank, exclusive handling of a country's use of U.S. commodity credits, preferential treatment on the processing of money coming in and out of the country where monetary controls were in place, the right to own a bank, secretly if necessary, in countries where foreign banks were not legal, or other questionable means of securing assets or profits. In return, BCCI would pay bribes to the figure, or otherwise give him other things he wanted in a simple quid-pro-quo.

The result was that BCCI had relationships that ranged from the questionable, to the improper, to the fully corrupt with officials from countries all over the world, including Argentina, Bangladesh, Botswana, Brazil, Cameroon, China, Colombia, the Congo, Ghana, Guatemala, the Ivory Coast, India, Jamaica, Kuwait, Lebanon, Mauritius, Morocco, Nigeria, Pakistan, Panama, Peru, Saudi Arabia, Senegal, Sri Lanka, Sudan, Suriname, Tunisia, the United Arab Emirates, the United States, Zambia, and Zimbabwe.

In 1977, BCCI developed a plan to infiltrate the U.S. market through secretly purchasing U.S. banks while opening branch offices of BCCI throughout the U.S., and eventually merging the institutions. BCCI had significant difficulties implementing this strategy due to regulatory barriers in the United States designed to insure accountability. Despite these barriers, which delayed BCCI's entry, BCCI was ultimately successful in acquiring four banks, operating in seven states and the District of Colombia, with no jurisdiction successfully preventing BCCI from infiltrating it.

The techniques used by BCCI in the United States had been previously perfected by BCCI, and were used in BCCI's acquisitions of banks in a number of Third World countries and in Europe. These included purchasing banks through nominees, and arranging to have its activities shielded by prestigious lawyers, accountants, and public relations firms on the one hand, and politically-well connected agents on the other. These techniques were essential to BCCI's success in the United States, because without them, BCCI would have been stopped by regulators from gaining an interest in any U.S. bank. As it was, regulatory suspicion towards BCCI required the bank to deceive regulators in collusion with nominees including the heads of state of several foreign emirates, key political and intelligence figures from the Middle East, and entities controlled by the most important bank and banker in the Middle East.

Equally important to BCCI's successful secret acquisitions of U.S. banks in the face of regulatory suspicion was its aggressive use of a series of prominent Americans, beginning with Bert Lance, and continuing with former Defense Secretary Clark Clifford, former U.S. Senator Stuart Symington, well-connected former federal bank regulators, and former and current local, state and federal legislators. Wittingly or not, these individuals provided essential assistance to BCCI through lending their names and their reputations to BCCI at critical moments. Thus, it was not merely BCCI's deceptions that permitted it to infiltrate the United States and its banking system. Also essential were BCCI's use of political influence peddling and the revolving door in Washington.

Federal prosecutors in Tampa handling the 1988 drug money laundering indictment of BCCI failed to recognize the importance of information they received concerning BCCI's other crimes, including its apparent secret ownership of First American. As a result, they failed adequately to investigate these allegations themselves, or to refer this portion of the case to the FBI and other agencies at the Justice Department who could have properly investigated the additional information.

The Justice Department, along with the U.S. Customs Service and Treasury Departments, failed to provide adequate support and assistance to investigators and prosecutors working on the case against BCCI in 1988 and 1989, contributing to conditions that ultimately caused the chief undercover agent who handled the sting against BCCI to quit Customs entirely.

The January 1990 plea agreement between BCCI and the U.S. Attorney in Tampa kept BCCI alive, and had the effect of discouraging BCCI's officials from telling the U.S. what they knew about BCCI's larger criminality, including its ownership of First American and other U.S. banks.

The Justice Department essentially stopped investigating BCCI following the plea agreement, until press accounts, Federal Reserve action, and the New York District Attorney's investigation in New York forced them into action in mid-1991. Justice Department personnel in Washington lobbied state regulators to keep BCCI open after the January 1990 plea agreement, following lobbying of them by former Justice Department personnel now representing BCCI.

Relations between main Justice in Washington and the U.S. Attorney for Miami, Dexter Lehtinen, broke down on BCCI-related prosecutions, and key actions on BCCI-related cases in Miami were, as a result, delayed for months during 1991. Justice Department personnel in Washington, Miami, and Tampa actively obstructed and impeded Congressional attempts to investigate BCCI in 1990, and this practice continued to some extent until William P. Barr became Attorney General in late October, 1991.

Justice Department personnel in Washington, Miami and Tampa obstructed and impeded attempts by New York District Attorney Robert Morgenthau to obtain critical information concerning BCCI in 1989, 1990, and 1991, and in one case, a federal prosecutor lied to Morgenthau's office concerning the existence of such material. Important failures of cooperation continued to take place until William P. Barr became Attorney General in late October, 1991. Cooperation by the Justice Department with the Federal Reserve was very limited until after BCCI's global closure on July 5, 1991. Some public statements by the Justice Department concerning its handling of matters pertaining to BCCI were more cleverly crafted than true.

When Hill and Knowlton accepted BCCI's account in October, 1988, its partners knew of BCCI's reputation as a "sleazy" bank, but took the account anyway. In 1988 and 1989, Hill and Knowlton assisted BCCI with an aggressive public relations campaign designed to demonstrate that BCCI was not a criminal enterprise, and to put the best face possible on the Tampa drug money laundering indictments. In so doing, it disseminated materials unjustifiably and unfairly discrediting persons and publications that were telling the truth about BCCI's criminality.

Important information provided by Hill and Knowlton to Capitol Hill and provided by First American to regulators concerning the relationship between BCCI and First American in April, 1990 was false. The misleading material represented the position of BCCI, First American, Clifford and Altman concerning the relationship, and was contrary to the truth known by BCCI, Clifford and Altman.

Hill and Knowlton's representation of BCCI was within the norms and standards of the public relations industry, but raises larger questions as to the relationship of those norms and standards to the public interest.

BCCI's decision to divide its operations between two auditors, neither of who had the right to audit all BCCI operations, was a significant mechanism by which BCCI was able to hide its frauds during its early years. For more than a decade, neither of BCCI's auditors objected to this practice.

BCCI provided loans and financial benefits to some of its auditors, whose acceptance of these benefits creates an appearance of impropriety, based on the possibility that such benefits could in theory affect the independent judgment of the auditors involved. These benefits included loans to two Price Waterhouse partnerships in the Caribbean. In addition, there are serious questions concerning the acceptance of payments and possibly housing from BCCI or its affiliates by Price Waterhouse partners in the Grand Caymans, and possible acceptance of sexual favors provided by BCCI officials to certain persons affiliated with the firm.

Regardless of BCCI's attempts to hide its frauds from its outside auditors, there were numerous warning bells visible to the auditors from the early years of the bank's activities, and BCCI's auditors could have and should have done more to respond to them.

By the end of 1987, given Price Waterhouse (UK)'s knowledge about the inadequacies of BCCI's records, it had ample reason to recognize that there could be no adequate basis for certifying that it had examined BCCI's books and records and that its picture of those records were indeed a "true and fair view" of BCCI's financial state of affairs.

The certifications by BCCI's auditors that its picture of BCCI's books were "true and fair" from December 31, 1987 forward, had the consequence of assisting BCCI in misleading depositors, regulators, investigators, and other financial institutions as to BCCI's true financial condition.

Prior to 1990, Price Waterhouse (UK) knew of gross irregularities in BCCI's handling of loans to CCAH/First American and was told of violations of U.S. banking laws by BCCI and its borrowers in connection with CCAH/First American, and failed to advise the partners of its U.S. affiliate or any U.S. regulator.

There is no evidence that Price Waterhouse (UK) has to this day notified Price Waterhouse (US) of the extent of the problems it found at BCCI, or of BCCI's secret ownership of CCAH/First American. Given the lack of information provided Price Waterhouse (US) by its United Kingdom affiliate, the U.S. firm performed its auditing of BCCI's U.S. branches in a manner that was professional and diligent, albeit unilluminating concerning BCCI's true activities in the United States.

Price Waterhouse's certification of BCCI's books and records in April, 1990 was explicitly conditioned by Price Waterhouse (UK) on the proposition that Abu Dhabi would bail BCCI out of its financial losses, and that the Bank of England, Abu Dhabi and BCCI would work with the auditors to restructure the bank and avoid its collapse. Price Waterhouse would not have made the certification but for the assurances it received from the Bank of England that its continued certification of BCCI's books was appropriate, and indeed, necessary for the bank's survival.

The April 1990 agreement among Price Waterhouse (UK), Abu Dhabi, BCCI, and the Bank of England described above, resulted in Price Waterhouse (UK) certifying the financial picture presented in its audit of BCCI as "true and fair," with a single footnote material to the huge losses still to be dealt with, failed adequately to describe their serious nature. As a consequence, the certification was materially misleading to anyone who relied on it ignorant of the facts then mutually known to BCCI, Abu Dhabi, Price Waterhouse and the Bank of England.

The decision by Abu Dhabi, Price Waterhouse (UK), BCCI and the Bank of England to reorganize BCCI over the duration of 1990 and 1991, rather than to advise the public of what they knew, caused substantial injury to innocent depositors and customers of BCCI who continued to do business with an institution which each of the above parties knew had engaged in fraud.

From at least April, 1990 through November, 1990, the Government of Abu Dhabi had knowledge of BCCI's criminality and frauds which it apparently withheld from BCCI's outside auditors, contributing to the delay in the ultimate closure of the bank, and causing further injury to the bank's innocent depositors and customers.

While to some degree we believe that we have somewhat pushed then envelope in quoting the Foreign Relations Report on BCCI, we wanted to make it crystal clear that this was no minor happening and without tremendous assistance from BCCI’s credible accounting firm, this scandal would have certainly be nipped before it became a global problem. While it is certainly true that Price Waterhouse was not the only culprit in this cesspool, they knew what was happening and when it happened and did not lift a finger to stop it.

Moreover, it is our belief that had the BCCI scandal transpired ten years later; it would have brought down the world’s financial systems. In the early 1980s, derivatives had not yet appeared on the scene and electronic transmission had not yet matured. The subversive power of today’s financial mechanisms would have triggered a decades-long global depression. Yet, the accounting firm’s that were auditing BCCI’s books to our knowledge, never brought any of those activities to the attention of regulators. They continued to allow the Bank to function as a going business long after they should have been closed and sent to pasture. They turned a blind eye when the bank to engaged in money laundering to such a large degree that they were cleansing funds for most major criminal organizations on the planet.

The same forces that would have turned a BCCI into the trigger for a world financial meltdown would make Credit Lyonnais’ debacle particularly dangerous.

Credit Lyonnais, Vive La France’

Credit Lyonnais was and is a chattel of the French Government, the victim of the biggest measured internal bank fraud in history. Today, over a decade after the French public decided that the bank’s mismanagement had gone on far too long, most of the pieces to the puzzle are still missing and investigations are still continuing.

For decades, the officials of Credit Lyonnais were literally “the gang that couldn’t shoot straight.” ([15]) Everything they ever did was wide of the mark, and it took the resources of the French Treasury to bail out the sinking ship. Bad loans on the bank’s books totaled a staggering $35 billion ([16]) when originally reported, but recently discovered indicate that even this number is far too conservative.

An in-house newsletter, published by the Consortium de Realization (or “CDR”), said: “investigations into Credit Lyonnais and its subsidiaries had shown how the bank’s senior management had allowed the fraud both in France and abroad. The further CDR’s team goes…the clearer it becomes: There was organized financial fraud until 1993…. The fraud was concentrated in seven subsidiaries…, which acted as the unbridled horsemen of this financial apocalypse. The real figures involved are substantially greater than those recently quoted, already huge.”

In March 1997, CDR’s Chairman, Michel Rouger, was quoted by a French legislator as telling a parliamentary commission that about five billion francs had been embezzled by bank executives and businessmen with links to the bank.” ([17]).

Credit Lyonnais’ banking practices during that period, can be illustrated by describing the bank’s relationship with an Italian thug by the name of Giancarlo Paretti, whose rap sheet was almost unlimited. The Bank, whose senior officers had been bribed by Paretti, knowing his criminal background, extended over $2 billion him, enabling him to acquire and run companies. His primary acquisition was MGM.

The crimes of which he was convicted included:

Fraud in connection with the bankruptcy of IL Dirario newspapers, sentenced to: 3½ years in prison. Under appeal. March 1990.

Fraud in connection with the Siracusa soccer team.1975

Fraud in connection with a Hotel company in Sicily. 1984

Forgery in connection with savings bonds in Sicily. 1984

Bankruptcy of a newspaper in Paris named Le Matin, 1986

Judgment, Credit Lyonnais, June 1997. $1,466 billion, MGM

Convicted perjury and evidence tampering, Delaware, 1996

Fugitive from justice, flight to avoid imprisonment, 1996

Parretti’ s partner in his dealings with the bank was Florio Fiorini, currently serving time at Champ Dollon prison in Geneva. According to Fortune Magazine (7/8/1996), “[Fiorini] has figured in every major financial and political scandal in Italy in the past two decades—and that’s saying a lot. He learned political bribery and global money laundering at the knees of the notorious Vatican-connected Italian bankers Michele Sindona and Roberto Calvi, whose violent deaths in the wake of banking scandals in the 1970s and 1980s remain unsolved.

His mentor was Bettino Craxi, the former Prime Minister of Italy and Socialist Party chairman; and Gianni DeMichelis, the former Italian Foreign Minister, who spent his nights in discotheques. According to Fiorini, Craxi and DeMaichelis took bribes from Paretti and Fiorini to induce the French government and its bank (Credit Lyonnais) to back the Italians’ purchase of MGM.

Parretti’ s background was no secret:

“According to Jerry Brodsky (head of due diligence for Drexel Burnham Lambert) Giancarlo Paretti asked Drexel in the late 1980s to help raise the money he needed to buy MGM. When Kroll’s (private detective agency) agents reported that Parretti had been convicted of fraud in Italy, Brodsky nixed the deal. Instead Credit Lyonnais loaned Parretti the money—something it’s since regretted, since much of the money vanished, along with Parretti himself” ([18]) ([19])

In spite of Credit Lyonnais, being informed of Parretti’s background and associates on numerous occasions, the Bank continued extending him credit, which exceeded $2 billion when it had had enough. The reason Paretti had been able to continue using the Bank’s money for his schemes was simply that he had bribed the senior Bank officers.

Georges Vigon – head of European lending for Credit Lyonnais until his ”departure.”

Jacques Griffault – head Credit Lyonnais, Milan branch.

Jean-Jacques Brutschi- head of Credit Lyonnais, Holland.

In Geneva, a judge eventually charged Credit Lyonnais Chief Executive Jean-Yves Haberer ([20]) and General Manager Francois Gill with fraudulent complicity. Haberer credentials were superb. He went to all the right schools, graduated at the top of his class, knew all of the right people, and did all of the right things. There was only one thing wrong; he just could not legitimately run a bank or probably anything else for that matter:

“An arrogant man, Haberer held himself aloof from everyone at the bank except his immediate colleagues, an inclination symbolized by his installation of a “floating floor” of felt, rubber and cork under his lavishly appointed office to insulate it from the noise of the street, the Metro, and, his detractors said, the real world. They started calling him “le megalo”—the megalomaniac.” ([21])

Within five months of the time Paretti took over MGM, with the help of Credit Lyonnais’ loans, it was bleeding at the rate of $1 million per day and was a bankruptcy candidate within five months. The Bank ultimately took over MGM and was forced to sell it at a staggering loss.

Now, too much of this kind of thing can give banking a bad name. These were trusted employees splitting the loot. If you can’t trust trusted employees, who can you trust? Credit Lyonnais, during a substantial period of time, was not just out of ratio; it was bankrupt, but doing business. Had the Government of France bet the country on a successful bailout, a true international debacle would have ensued. The French People will be paying a staggering price for many years to come. The only saving grace was that the Credit Lyonnais scandal occurred in the 80s rather than the late 90s.

And yet, in the midst of attempting to put a badly mangled house back in order, Credit Lyonnais again went on the offensive and found a way turn victory in defeat. Few felt that the bank’s management had anything but a death wish when, in Asia, they started lending everybody and anybody that they could find, knowing that the situation was perilous. Among a portfolio of bad investments, one item stands out, Garuda Airlines. Credit Lyonnais was there with the fastest check in the west and now, payments have stopped and the bank is “sucking wind.” “While the (Asian) loan problems are not expected to severely damage any of the banks, one bank could have serious problems: Credit Lyonnais, a long-troubled French financial institution.” ([22]) This is an ill-stared institution and the French would probably be better off pulling the plug and putting the bank out of its misery.

In the meantime, looking for a patsy, recently, Credit Lyonnais has filed an action against the Dutch subsidiary of KPMG looking for about $2 billion. The suit indicates that when the bank (Credit Lyonnais Bank Nederland) lent money to MGM, KPMG had already discovered a large-scale fraud in 1989 but provisions for loans in 1989, ’90 and ’91 were not only adequate but no addition investigation was necessary. In the action in question, the Dutch apparently feel so strongly that they got the shaft from KPMG that they are also holding 160 KPMG employees responsible for the action as well as the KPMG parent. Major league!

Now the bank is facing serious problems in the United States. A French whistleblower informed various parties that the transaction consummated in the early 1990s between the California Commissioner of Insurance acting as the liquidator of Executive Life and Credit Lyonnais was fraudulent. Executive Life was the largest American Insurer to go out of business to that time. It was taken down because of a combination of a proliferation of junk bonds in its portfolio and a bad market for debt instruments in general. The California Department of Insurance put the company and the portfolio up for joint bid and the winning bid was ultimately made by a consortium consisting of a group put together by Credit Lyonnais and a handful of ex-Drexel Burnham executives.

This wasn’t even a fair battle, the insurance commission was advised that the transaction put forth by this group was inferior to others that the background of the people was questionable to say the least, but he made the transaction anyway much to his long-term regret. Among the nuances of the transaction was the that neither the government nor bank; Credit Lyonnais could own an American Insurance Company under the existing Glass Steagall prohibitions. Furthermore, under California law, a foreign government could not own an California domiciled American insurance company. The California Department of Insurance and the Executive Life policy holders were still smarting over the mistakes of almost a decade ago committed by an Insurance Commissioner who was indirectly running for Governor of California the entire time he held that office.

He seemed more interested in making boisterous statements of how well he was doing than actually doing anything of consequence that would help anybody. When the whistleblower blew his whistle in California it seemed like an opportunity for the State to undo that entire transaction because of its illegality and they have filed lawsuits against the bank and just about everyone else that had anything to do with the matter. In the meantime, the Commissioner has called out just about everyone but the National Guard in an attempt to investigate the matter. The Federal Bureau of Investigation, The Justice Department, and Department of the Treasury are all conducting investigations into what will soon turn into a very serious matter. We believe that this is the second coming of Daiwa Bank who folded its tent in the United States after actions were filed against it for, in effect, lying to the Federal Reserve.

This case make may that one pale in comparison. It appears that Credit Lyonnais lied about their position from the very beginning to take advantage of something that they knew was illegal. Daiwa got themselves into a fix by accident and just did not know how to legally extract themselves from the problem. Two very different matters. The French Government is so concerned about the matter that they. The overall inquiry of what has occurred at the French Bank has been called the largest investigation of its kind ever conducted in France.

“…Even a former governor of France’s central bank has been questioned. Investigators have discussed with other top officials whether their actions or inactions might have fostered Credit Lyonnais’ frauds and losses. Prominent financiers, well-known in global banking circles, face possible imprisonment, financial calamity and public disgrace.” ([23])

Interestingly enough, Credit Lyonnais as already had been hit with a substantial fine in the MGM matter. In that settlement, the bank agreed to refrain from committing any felonies in the United States. If they violate that settlement, the penalties in that case skyrocket almost 400%. It would seem that there is no question that this has already occurred.

In today’s banking system, the presence of a BCCI along with a savings and loan scandal and/or a long-lead time disaster like that at Credit Lyonnais, could bankrupt the healthiest sectors of the world’s economies. The same court in Paris is hearing the claim against KPMG that years earlier fined Paretti one million francs for fraud in the same deal. When he didn’t show up to pay the fine, he was given an additional gift of four years in a French prison. With this kind of history, KPMG probably better start taking its checkbook out of the drawer and checking with its insurance carrier.

The Savings And Loan Crisis, One of The Most Costly Series of Frauds In American History.

All I Want Is A Couple Of Bucks Under The Table And You Can Have Your Jumbo Mortgage!

Sounds good in principal, but is it that good in practice? At the same time that the Savings and Loan crisis occurred in the United States, the banking system became simultaneously, totally insolvent. The two had roots in some of the same general problems. Real Estate values collapsed on loans made by both banks as well as by Savings and Loans. Believe it or not, values depreciated across the board and both industries had a pro rata share of disasters. Luckily for the banks, they were more diversified, and thus were cushioned by other loans. However, unluckily for the banks, their South American loans became worthless at the same time. If one was doing cost accounting on the simultaneous disasters and concentrated on both the top ten U.S. Banks and the top ten thrifts, it is my belief that they were all equally bankrupt. The thrifts from bad domestic loans and poor management, the banks from a combination of domestic and foreign loans.

In just 10 years, from 1980 to 1990, of the 13,500 banks in the United States, 1,500 failed. A survey conducted by Heidrick and Struggles Inc., an executive recruiter, and the American Banker, concluded that almost 50% of the bank officers currently employed were incapable of dealing with the problems that would exist in a deregulated environment.

New York had not had a bank failure since the 1930s, and when Greenwich Savings Bank collapsed in 1981, it caught everyone by surprise. After all, hadn’t The Greenwich been in business for almost 150 years, with assets in excess of $2 billion? Those that formed the line the day after also formed the nucleus of the first run on a bank in the United States in over 50 years. Nobody went to jail, there weren’t any really horrendous loans and with the exception of the FDIC, almost everyone was made whole. It was just a case of a bad economy and a Federal Government that either had not come to grips with the infrastructure problems that were being created or were stultified by their own inexperience.

“So what’s the big deal? I mean, for the most part here we are talking about serious fraud. We really aren’t interested in a bank that just went, there must be more to the story.”

Well, you’re right, but sometimes things just kinda happen, even when people really mean well, but just are kinda dumb when it comes to economics. You see, Jimmy Carter, a well- meaning guy, never found out that Savings Banks loan money for up to 30 years, while they borrow from customers for less than 5 years. If short-term rates ever became higher than long-term receipts for any protracted period of time, literally the entire industry would fail. The rates did and the industry did. It was only the magic of accounting and a government bailout of immense proportions that preserved anything at all. The banks, which were restricted from lending long, were able to prevent collapse despite holding as many disastrous real estate loans as the S & L’s, and struggling with defaulting Latin American debt. With the entire S & L industry stultified, banks were able to step into the breach with high interest loans and provide a perceived safe harbor for investor’s funds that had fled their competitors. The saving grace may well have been that the run on the thrifts caused money to pour into the drought filled banking industry.

The prime rate hit 21 percent in 1981, causing investors to withdraw their money from the Savings and Loans, which could not pay over 5.5 percent. The majority of the funds were deposited into money market funds and the banks, where six month CD’s were yielding 15 percent. Because failures were occurring faster than they could be absorbed by the system, the FSLIC changed the adequacy rules, allowing some breathing room for the regulators, while staving off total panic among depositors. The failure of the press to totally grasp the gravity of these events was the economy’s ultimate salvation. Having bought time to grab a breath or two, a few S & L’s were shorn up, merged or liquidated, and calm returned, for a time, to the system.

The Fed feeling that inflation had been brought under control turned the spigot on again in earnest. The regulations governing the S & L’s borrowing policies were loosened, and they borrowed to the hilt. Historically, the savings and loans were more a local enterprise, as opposed to a money center banking institution; they became overzealous lenders in an attempt to make back their losses of the previous 5 years. Loans were made everywhere and anywhere, in all areas allowed by the regulators, and frequently in areas that were not. Money was thrown at developers and cities like Houston, Dallas, Denver and Phoenix became monuments to the god of vacancy. The Savings and Loans had done it to themselves all over again.

The debacle of the Thrifts cost the taxpayers almost $100 billion dollars.

We have listed a few and they’re cost to taxpayers and disposition of principals in 1993:

Lincoln $2.6 billion Charles Keating, serving 10 Year

Sentence

Vernon $1.0 billion Don Dixon, 10-year sentence

CenTrust $1.6 billion not determined, Up to 10 years

Columbia $2.0 billion facing charges and $40 million in

Damages

Silverado $1.0 billion Director Neil Bush agreed to pay $50 million to settle charges.

What Hath Michael Milken Wrought?

Within three years, the industry literally collapsed twice, for two very different reasons, one the drought of funding and the other the riches of funding. Loopholes opened to provide survival escape routes in bad times were left open and created the excesses of the good times. The Savings and Loans have easy access to people with bankrolls that could acquire the weaker businesses of the very early 80s. The institutions were then allowed to merge and acquire beyond the scope of their charters. Junk bond funding provided much of the fuel for the conflagration, which was ignited by inept management. How soon we forget!

The Big Eight, Err Six, I Mean Five And The Savings And Loan Industry

What Do You Think I Am? A Squealer?

There were many accounting firms that got into trouble over their audits of Savings and Loans. Various explanations have been put forward for the fact that no member of the Big Six came away unscathed. In a general sense, there were a great number of inquiries into what could have caused everyone to have gone wrong simultaneously. Their report, in part, stated:

“The AICPA Audit and Accounting Guide for Savings and Loan Associations was last substantially revised in 1979. It contains little discussion of the risks associated with the land and ADC loans; ([24]) the effect of increases in restructured loans on collectability; coordinating audit work with the results of regulatory examinations; the importance of disclosing regulatory actions and violations to depositors, shareholders, regulators and other users of audit reports.”

Although the then Big Six now proclaim their innocence in the S & L crisis, (‘It wasn’t our job to find fraud,’ they insist), a General Accounting Office study of eleven bankrupt thrifts revealed that the audits for six of the S & L’s failed “to meet professional standards.’ The firms involved included Arthur Young, Deloitte Haskins & Sells and Ernst & Whinney. ([25])

Moreover, the cause was more one of unhealthy relationships between the S & L’s and their auditors, greed by accounting firms in bringing in business at any cost and, more important was the fact that the accounting firms just weren’t up to recognizing the sophistication of the new financial instruments being purchased by the Savings Banks. The latter problem bodes for firm requirements in accounting and for increased continuing education, within particular areas of audit. Additionally, if teams of industry specialized (dedicated) auditors had to be certified in order to conduct the certification process, the excuses given for the total incompetence of the Big Six in their S & L audit would have fallen under their own weight.

In many cases, management of troubled S & L’s contended that problem loans were collectible or, in cases of default, that collateral underlying the loans was sufficient to cover the outstanding loan balance. Standards require auditors to obtain independent corroboration that key management assertions are true – often a time-consuming, but necessary audit function. However, the CPA’s in our review did not always perform this function and, instead, often relied on management’s unsubstantiated oral assertions that problem loans were collectible.

“In two cases in our review, CPA’s did not point out in their audit reports that their S & L clients had materially misstated their income. In one of those cases, the S & L client had lost four times as much money as it had reported in its financial statements for that year.”

“In some cases, CPA’s did not report serious regulatory violations, such as excessive loans to single borrowers and formal cease-and-desist or similar orders by regulators. Thus, report users were unaware of those operating risks and the corresponding potential regulatory actions, all of which may have impacted the S & L’s operation.” ([26])

The Carter Years

During the Carter years, interest rates, as we all know, went through the roof. Savings and Loans had numerous restrictions on lending and borrowing (raising money in one form or another) that did not encumber the banks. Banks for example, would historically tie their loans to the "prime rate,” Libor or any number of other potential scenarios that could be thought up to work profitably on their behalf. Thus, the bank always had a profit locked in. The loan would carry an interest rate of, let us say prime plus two or whatever else. Whenever the prime rate changed the customer’s interest rate either rose of fell.

The Savings & Loans were not allowed this escape valve and they were constantly in a position of lending long and borrowing short. Thus, as rates rose, a number of very unpleasant things would happen to the Savings & Loan industry. In addition, Savings Bank's main source of funds was what we call certificates of deposit or CDs. These instruments were usually issued for a year at a time with a fixed rate of interest. On the other hand, they could be issued for another year or two if both the issuer and the purchaser agreed.

Therefore, by picking a starting date where all of our numbers are constant, the Savings Bank would have a portfolio consisting of mortgages that they had issued to people purchasing homes or business property and certificates of deposit that their customers had purchased from the institution. There is no question that there are other items, which make up the balance sheet mix but in comparison to these two, they would be insignificant. Undoubtedly, the S & L had equity; it probably had preferred and certainly had assets such as a home office, furniture and the like. It would also have money on deposit with the FSLIC or State insurance fund. These numbers when looking at the total health or sickness of an institution in this industry were just not consequential.

Having dispensed with that piece of housecleaning, let us make the assumption that the portfolio of our institution, Ajax Savings Bank is $100 million consisting of 2-year average maturity certificates of deposit paying their owners 5% interest per year. On the asset side of the ledger, we would see that Ajax had $100 million of mortgages receivable bringing in approximately 7 1/2% interest and averaging 25 years remaining on their maturity. By simple arithmetic we can easily see that under the circumstances outlined above, Ajax seems to be in good shape with income exceeding payments by $2.5 million per year before salaries, mortgage defaults, rent, professional fees and other sundry charges. Most probably, if Ajax is well managed, it will return a tidy profit to shareholders and principals.

Now, lets kick interest rates up a notch as the Federal Reserve did under the Carter Administration. With Burt Lance, a corrupt banker guiding him, America's ever faithful president from the state of George thought that more was better and allowed rates to climb into the stratosphere. Banks were charging 22% and people were happy to pay it and you could get 17 1/2 percent interest on your CD's. These rates eventually broke the real-estate market’s back. New buyers couldn't afford to buy anything and sellers unless they had transferable mortgages, were unable to provide financing for their properties. Building came to a screeching halt.

Hypothetically, the new Savings Bank picture looked as follows: The bank was still receiving 7 1/2 percent on the mortgages that had not run off. Assuming that no new mortgages were written, which was just about the case, and the average loan had been for 25 years, 2/25 of the mortgages no longer existed or about 8 percent. Eight percent subtracted from $100million gave the Savings and Loan about $92 million in mortgages and for the moment let us assume that everything else was equal, which it wasn't, $92 million in Certificates of Deposit. The Certificates of Deposit would have been re-written by this time and let's make the assumption that the rate was now 12 1/2 percent. (Which appears to be conservative under the circumstances) Thus, the Savings Bank under this scenario was now losing about $5 million per year and this was before any expenses. At this point in time were are talking about, $5 million in net capital for a Savings Bank was not a bad number and as you can see, the entire equity would have eroded within approximately eight months.

However, the story was far worse than that. People weren't sure what was going to happen next. They had completely lost confidence in the Carter Administration and if it made sense to squirrel their money under the bed that is what they would have done. The Federal Savings and Loan Insurance Corporation (FSLIC) was totally out of money as 500 institutions had already collapsed with thousands more on the brink. Banks on the other hand appeared much safer, the government seemed to be willing to throw money at them in order to restore confidence and keep them solvent, and the banks were not bogged down with the awful real-estate portfolios that were sinking the Savings Banks.

Actually, the banks were in much worse shape ([27]), in spite of having more diversified portfolios. The banks saw an opportunity to make quick money in Latin American, invested almost everything there, and the countries tanked. In order to prevent financial chaos, the Treasury came up with all manner of new rules, which made the worthless collateral that the banks were holding appear to have value, at least from a regulatory point of view. The American Government stiff-armed both the International Monetary Fund and the World Bank to throw dollars at the problems in Latin American and ultimately the countries were able to come back. Lastly, the government mandated that the usurious interest charged by credit card companies owned by the banks was somehow totally legal.

This form of debt floated with the prime rate and if the banks decided to make more money all that they had to do was widen the differential between lending and borrowing. The same option was available on Bank Savings Accounts, which normally paid interest based on either the prime rate, the discount rate or Libor, whatever worked the best for those institutions. Thus, while both the Saving and Loans and the banks were in equally precarious positions, the U. S. Government having only enough credit U.S. Government to save one or the other, naturally chose to save the banks.

The Reagan Years

An ex-actor named Ronald Reagan blew Carter out of the White House. Reagan concocted all kinds of new economic theories that sounded good but that nobody understood and that was the way it was meant to be. They did know that anything was better than the peanut salesman from Georgia and his band of crackers. Reagan espoused some unknown philosophy he referred to as deregulation. It was intended to let everyone do whatever they wanted. When we went to school, we called it anarchy and we were told that these kinds of people were murderers and even worse. By calling it deregulation, none of the college professors were able to determine what he meant and many said that it must be good.

However, it was good for some and very bad for others. Let us take a look at the differences between three very different industries; Banking, Stock Brokerage and Savings and Loans. We are only going to analyze them from one point of view and that is what effect deregulation would have on each of them. Let's take a look at the Savings Bank first. The average head of a Savings Bank knew every piece of property within his lending area. He had probably grown up in the neighborhood and inherited his position from his father. He or other people at the S & L knew the borrowers and what kind of people they were and what kind of jobs they had. They also knew what the replacement cost was on the property that they held as collateral and they knew what the percentage of equity they had.

All in all, they were very knowledgeable lenders and as long as anything didn't go too far askew, they would be in good shape. On the other hand, they knew nothing about the outside world, their employees were minimum wage people that lacked any skills whatsoever. They could be trained to perform reasonably in the one-dimensional job they had but, asked to split the atom or find their way downtown, they would be equally lost with either scenario.

These were the guys on the firing line when things did go askew and they were still there when the actor came up with his new plan to save the world. Deregulation was the Savings and Loan industry's poison pill. Suddenly, they could get involved in other securities, buy buildings instead of only lending on them, purchase corporate bonds and even take over their competitors. The only thing wrong with this is that they all tried at once to turn an industry that had not ever made a change in philosophy into one that didn't know which street to go barking up next. There was also this guy in New York at that big fancy brokerage firm called Drexel Burnham. You know, Members of the New York Stock Exchange, these guys had a fellow there that specialized in helping the Savings Banks get higher interest rates with things called junk bonds. Although they didn't sound very nice, he assured everyone that these bonds would perform and by buying these instead of putting on mortgages you could substantially improve your overall yield. These junk bonds came with things called kickers as well. They also had warrants, rights, and convertible features. They even came with things that were hard to understand called exploding equities.

Those young men from Wall Street would come to call in their pin striped suits and they would sell the savings bank people things called repo's and then they wanted them to buy reverse-repo's which seemed to be the opposite of the repo's. No one understood either so it didn't matter a lot but it appeared to be good and this became when of the best reasons for thrift failure the we are aware of. Some of these fellows explained to the heads of the Savings Banks that by lending the brokerage firms their hard earned collateral, they would become rich. They would give the brokers their collateral and get back something less. Usually the broker used the difference to support and affluent life-style. This allowed the broker to con even more savings & loan people because they saw the fancy cars and the planes and the beautiful women and homes and they wanted into the action as well. If by giving the broker some of their collateral it would get them the better things in life, they wanted in. What they got for their trouble, usually was a Chapter II filling, they weren't it was Chapter VII. They didn't seem to want to understand the highly difficult concept that there is really never any free lunch.

This was, when all was said and done, like taking candy from a baby. Not one of these schemes was destined to work for the Saving & Loans although the brokers made a pretty penny in the process. It was just a matter of highly educated people in pin stripped suits spouting a lot of big words doing to the S & L's what the traveling medicine men did to the same townspeople a hundred years before. The only difference was that most of the townspeople survived the medicine and were out only a couple farthings. The pinstripes left the S & Ls and buried and their guy in charge not only lost everything but stood a good chance of going to jail for among other things, criminal stupidity.

Along with these "tools for idiots" many of the Savings Banks started issuing instruments called "Jumbo CDs.” A Jumbo CD was a CD on steroids that carried a substantially higher rate that the regular issue variety. On the other had, the purchaser had to go for a lot more money and keep the CD on the rolls of the S&L for an extended period of time. These products only made the end come sooner to the institutions that were issuing them. The higher rates on a greater number of instruments made them only that much harder to service.

I think you are beginning to see the point but let me talk for a minute about the banks and the brokerage firms just to make a point. After the 1929 crash, the banks were very much made the fall guys for the fiasco. In spite of the fact that history has proven that they didn't do a lot of the things that they were accused of, there had been a heist in town and someone was going to dang well swing for it. The banks swung. An law called the Glass Steagall Act was passed and in general it prevented the banks from going into business that they owned other than banking, sticking within their territory, lending money and charging interest. Not a lot different than the regulations governing the thrifts.

While the United States Banks were hamstrung, the banks in the rest of the world resembled the Wild West. Regulations if they existed at all were weak and not enforced. After World War II had ended, the global banking systems were in taters and the only place on the globe where there was an appreciable amount of money was the United States. The American banks were not restricted from investing in foreign subsidiaries that had to conform with local laws, which more often than not didn't exist. American Banks somehow or another got into almost every business in the world through their overseas investments and whenever Congress determined that they were pushing the envelope, the banking lobby stepped up to the plate and brought the votes.

The Saving & Loans on the other hand were restricted from making these kinds of investments and was far from organized politically the way the banks were. They had no agenda and were staffed with people who were unaware of what was going on in the next neighborhood; forget about Europe or the Far East. Where money center bank employees came from the Ivy League, Savings and Loans senior executives went to the school of hard knocks and there was not a college graduate in the average institution throughout the 1960s and 70s. Deregulation to this group of locals was like throwing oil on a fire. It would consume them.

The stock brokerage business was similar to the banks. They had more leeway relative to product development and with the help and guidance of the Securities and Exchange Commission they were able to come up with a string of new products to entice investors. Pay on Wall Street in the employee of brokerage houses was even better than it was in the money center banks and the top of the “B” School class gravitated to the Street. Brokerage houses invaded Japan before the banks ever thought of the idea and they were in London soon after World War II had ended. Eventually their nets encompassed the free world and as in the case banks, overseas regulations were slim or non. Brokerage firms were highly qualified to exist in Reagan's deregulated environment. They had been doing it for 40 years. Matching these guys up against the S & Ls was just a game in seeing how long it took to literally clean the community they were in bone dry. Instead of deregulating, Reagan should have enlisted the help of the National Guard when the slaughter became uncontrollable.

Beverly Hills Savings & Loan, A Trustworthy Institution

Beverly Hills Savings and Loan is an institution that made everyone one of the mistakes listed above and probably a number that we haven't even touched on. Their first move was to change from a Federally Chartered S & L to a State Charted institution. Thus, they were able to become even more aggressive with their actions as the California Charter allowed even more leniency than did the Federal Charter. Jumbo Certificates of Deposit was the next important field of endeavor for Dennis Fitzpatrick, Beverly Hills Savings & Loan's (BHSL) chief executive officer. He went to the brokerage community for help and they were more than happy to oblige for a substantial fee.

The program was a success and mid-sized BHSL had grown in the four years from 1980 to 1984 from $290 million in deposits to $2.3 billion. The next order of importance was getting this money out-to-work profitably. The thrift entered into joint venture agreements with contractors that gave them a piece of the equity on the upside by literally giving up the comfort of being a creditor. Thus, they began betting big on the California real estate, which at the time was boiling. It soon turned ice cold.

In the midst of this no-lose program, a California developer noticed how BHSL had grown and bought a large block of the stock and announced that he was starting a proxy fight. Not wanting to share their potential profits with this interloper, BHSL brought in a white knight that was carrying around a lot of baggage. The white knight offered to help up proposed that he would exchange many of his properties for stock in BHSL. The stock would water the shares of the Savings Bank while putting more power in the hands of incumbent management. This temporarily kept the wolf from the door but took a big bite out of what had been a reasonable healthy institution. An independent study of one of the properties that had been assigned to BHSL by the White Knight should have sent a chilling message to the institution but they were forced to believe otherwise.

"With the exception of three buildings, the property has not been painted in some time, the gutters are falling down, the downspouts are off, porches have little or no screens, there is rotten wood, windows are broken, front doors are peeling, the landscaping is almost nonexistent, pavement is broken up, and large areas are not paved at all."

"Very large dogs roam the grounds, residents work on cars on Saturday and Sunday in the parking lots, motorcycles, bikes and neglected wood piles abound in breezeways, on patios, and on walks. Basketball goal sag, the word "pot" was spray-painted in white on the end of a two-story brick building. The laundry room, which was just completed six months ago, was filthy and looked about six years old. The pool area is scraggly; a cover on the pool has two feet of water on it. There is no pool furniture."

"An apartment was filled with sewage, under almost all of the building there is between three to fourteen inches of water, appliances are missing from almost all vacant units, all carpets need to be replaced, all appliances, if they are there, are in bad, if not inoperable condition, and should be replaced. This includes stoves, dishwashers, refrigerators, disposals, and traps.” ([28])

The White Knight had double dealt BHSL. The property discussed above turned out to be one of the better properties in the package that had been exchanged. BHSL in an effort to prop up their failing empire meet with Michael Millikan and his people. They were told to purchase some particular junk bonds that would solve all of their problems. Three hundred million was thrown at the junk bond market and it did not take long before the companies that they had invested in started to collapse like a house of cards.

In spite of new management assuming control, a close look at the books it now made it appear that things were going from bad to worse. In the third quarter of 1984, BHSL reported a $10 million loss as opposed to a profit in the previous period a year ago, but that was only the beginning. The 1984 audit of the company was delayed and a terse announcement made that the company could have suffered a loss of $100 million in the previous year. That was not particularly good news for shareholders in that the total assets of BHSL had only been $35 million at the start of 1984. Thus, anyone that had finished the second grade could swiftly figure out the fact that BHSL was under water by no less than $65 million.

There was no question that this represented a death knell for the company and everyone jumped in to find out what had gone wrong. Part of the report issued by the FSLIC was not kind to the auditors, Touche Ross. It said in part:

"…Touche rendered its written opinion that Beverly Hills Savings & Loan's consolidated financial statements "present fairly the consolidated financial position of Beverly Hills Savings and Loan Association and subsidiaries … in conformity with generally accepted accounting principles applied on a consistent basis.” At the same time Touché rendered these written opinions, it knew or should have known that such opinions were materially false, inaccurate and misleading in that BHSL's consolidated financial statements as of December 31, 1982 and 1983 did not present fairly the consolidated financial position of BHSL and subsidiaries as of those dates…” ([29])

Congress Takes A Look

This wasn't the only thing that Touche Ross did wrong. They had used some magical accounting in BHSL's entry into the construction business. When things didn't go as planned they switched to books around to reflect a deal, much different then the one that had originally had been made in order not to reflect the write-offs that would be necessary under the first arrangement. This Alice & Wonderland booking did not make any friends for Touche Ross in Congress and Mark Stevens in his Book, The Big Six once again shows us an interesting exchange that took place between Nelson Gibbs, a Touche Ross partner and Representative Dingell's subcommittee that was investigating the bizarre happenings at the Savings & Loan. Dingell ate Gibbs' lunch in an exchange.

Dingell: On what grounds could they be accounted for as loans?

Gibbs: Based on the contractual relationship between the parties and the equity in the interest

Dingell: What was the equity at this particular time?

Gibbs: The Amount of the equity?

Dingell: Yes

Gibbs: I don't know.

Dingell: Was there any equity?

Gibbs: I believe there was, yes.

Dingell: You believe or you know?

Gibbs: I believe there was. I don't know the amount.

Dingell: You don't know? You don't know the amount? You believe. Now, when one believes, one believes without knowledge. I believe in the Holy Trinity. I do not understand them. I have never seen them. I do not know what they look like. I do not know how they function together. But I believe in them. Bud I do now know. I believe.

But I know that you are sitting there at the witness table. That is knowledge. You understand the difference?

Dingell was only getting warmed up to the task at hand. Having philosophized with Gibbs relative to the meaning of life he got into the meaning of the agreements;

Dingell: What was it that caused Touche Ross to agree that these loans could be properly accounted for as loans rather than equity transactions.

Gibbs: The change in the relationship between the two entities, the legal form of the transaction, and the cross-collateralization agreement.

Dingell: Were any of these properties making money?

Gibbs: Most of the properties were servicing all prior debt, and in that context, there was positive cash flow.

Dingell: Positive cash flow, but were any of them making money?

Gibbs: Making money in a financial, accrual accounting sense, no.

Dingell: Okay. So in point of fact, money was moving through the books, but not enough to amortize the anticipated debt, is that right, to put it in layman's terms?

Gibbs: Yes, that would be a fair statement.

Dingell: So what they were doing, in point of fact, was really moving toward bankruptcy, is that right? When you have money moving through the books but not enough to pay off the debts, you are just moving slowly toward bankruptcy, or maybe you're moving very fast.

Once again, we come to rely on some of Mark Stevens’s research that appeared in his extraordinary book about the "Big Six.” He shows without question that the bank and everyone literally knew what was going on all the time. He quotes and internal memo from BHSL's internal auditor, Ellen Goodman that leaves nothing unsaid:

"We have completed nearly two years of audit procedures on the major loan files. The audit department's findings, McKenna's [McKenna, Conner & Cuneo, BHSL's outside legal counsel] findings and even the Leventhal [Kenneth Leventhal, a CPA firm specializing in real estate transactions] study all support the conclusion that remedial action is needed in major loan department operations. What is disturbing is not as much the severity of the errors as the volume of exceptions noted time after time. It would probably serve no useful purpose to correct most of the individual exceptions post mortem; however, the underlying fundamental issues do need to be addressed."

I would categorize these recurring problems as

(1) Violation of association policy and procedures

(2) Violation of regulatory requirements

(3) Inconsistencies and questionable practices…

Goodman went on to give chapter and verse:

"Staffing: It appears that everybody is conscientious and for the most part competent; however, the quality of the work is still lacking. With the rapid expansion of the department, it could just be that they are in over their heads with respect to organization, administrative abilities and technical expertise."

Regulatory Requirements: I have noted with one or two exceptions, no one in the major loan department has a copy of the California Guides. I recommend that several copies of these, and the regulations for other states in which the association conducts business, be maintained in the major loan department."

Goodman spoke plainly and there could be no question what was meant in the materials that she circulated in internal memos, which were given to the Touche Ross people. Their attorney admitted that the firm: "did review the internal controls at Beverly Hills and utilized the results of that review in setting the audit scope. Ms. Goodman's concerns as expressed at the time were taken into account in the course of the review."

We find it most pathetic that the internal auditor is telling everyone that wants to listen, literally that the institution is out of control, the accountants make absolutely no bones about the fact that they read the memo and yet the issued clean statements for the bank for the two years before it collapsed in a heap. We are talking about auditing errors literally in the hundreds of millions of dollars.

Once again, Congress wanted to know why the accounting firm had not listened to what they were being told. Touche while testifying and in particular discussing the records of former vice president Robert Newberry was told that all of his files were contained neatly in seven boxes and one box contained shredded paper work of the Newberry’s. Touche indicated to Congressman Wyden who was pressing the issue that it seemed odd that they could be happy with records that contained a shredded box:

"How can your firm be so sure in its conclusion that there were no irregularities when one of the eight boxes which contained relevant information was "accidentally shredded"?… Is the shredding machine at Beverly Hill big enough to shred an entire box of documents all at once, or do they have to feed the documents page by page? How an independent auditor could stand by and watch or, even worse, simply go along with the construction of an elaborate financial house of cards that ultimately consisted of nothing more that blue smoke and mirrors. When combined with an incredible series of poor investment decisions, mismanagement, and apparent self-dealing, the result was inevitable --total collapse."

We rest!

Call Me Mr. Keating, Sonny

Charles Keating was a former swimming champion and worked as a lawyer for raider Carl Lindner. It was from Lindner that he started his ball rolling by buying American Continental Corporation, a house-building company in Ohio in 1978. From there, he raised the money to acquire Lincoln Savings and Loan of California (Lincoln) through a junk bond offering floated by Drexel Burnham ([30]). In his commitment to the regulatory officials that controlled the thrift's license, Keating promised faithfully to stay with the course with the same management that existed before the takeover for the reason that the regulators felt that they had done such a good job. Moreover, the California regulators also extracted the promise form Keating that he would not sell jumbo CD's to facilitate the thrift's growth nor would he go out of the Savings & Loan's principal business of issuing home mortgages. Faster than you could say “liar, liar, your house is on fire”, Keating had fired the incumbent management, issued jumbo CDs and started working in concert with developers to get into massive proprietary real estate projects.

Once Charles became president of Lincoln and sold worthless bonds to 23,000 people, primarily California residents directly from the thrift’s branches, by causing them to somehow believe that the United States Government had guaranteed them. ([31]) When Lincoln was forcibly closed in 1989, only slightly more than 2% of the over $5 billion dollars in assets that Lincoln reported were in residential mortgage loans, almost 70% in risky land deals and eventually cost the taxpayers of the United States over $2.5 billion.

Lincoln’s investment philosophy under Keating’s guidance included takeover stocks, hotels, junk bonds, financial futures, and high-risk loans, which ultimately accounted for over 60% of the S & L’s assets ([32]). Keating took these investors for everything they invested, but that wasn’t all, the bailout paid for by American Citizens required another $2.5 billion before the loop was closed. Lincoln became the largest S & L failure in U. S. History and its conspirators were charged with concealment of illegal cash payments, securities fraud, racketeering, conspiracy, transporting stolen property, forgery, and false and misleading statements made to the regulators.

An example of the activities that were taking place during Keating’s reign at Lincoln is the following story that describes it to perfection:

“One of the most scrutinized of Lincoln’s multimillion-dollar real estate deals was the large Hidden Valley transaction that took place in the spring of 1987. On March 30, 1987, Lincoln loaned $19.6 million to E. C. Garcia & Company. On that same day, Ernie Garcia, a close friend of Keating and the owner of the land development company bearing his name, extended at $3.5 million loan to Wescon, a mortgage real estate concern owned by Garcia’s friend, Fernando Acosta, The following day, Weson purchased 1,000 acres of unimproved desert land in central Arizona from Lincoln for $14 million, nearly twice the value established for the land by an independent appraiser one week earlier. Acosta used the loan from Garcia as the down payment on the tract of and signed a non-recourse note for the balance. Lincoln recorded a profit of $11.1 million on the transaction—profit that was never realized, since the savings and loan never received payment on the non-recourse note.

In fact, Lincoln never expected to be paid the balance of the non-recourse note, Lincoln executives arranged the loan simply to allow the savings and loan to book a large paper gain. Garcia later testified that he agreed to become involved in the deceptive Hidden Valley transaction only because he wanted the $19.6 million loan from Lincoln. Recognizing a profit on the Hidden Valley transaction would have openly violated financial accounting standards if Garcia had acquired the property directly from Lincoln and used funds loaned to him by the savings and loan for his down payment. Acosta eventually admitted that his company, Wescon, which before the Hidden Valley transaction had total assets of $87,000 and a net worthy of $30,000, was only a “straw buyer” of Hidden Valley property. In a Los Angeles Times article, Acosta reported that Wescon “was too small to buy the property and that he signed the documents without reading them to help his friend, Ernie Garcia”[33]

Keating couldn’t have stolen $250 million without substantial help. Three accounting firms, Arthur Andersen & Company, Touché Ross & Company and Arthur Young and Company, along with three law firms, Kaye Scholer; Sidley and Austin and Jones Day, stock broker, Drexel Burnham Lambert and Michael Milken individually paid over $240 million in settlements regarding their actions in regard to Lincoln’s failure. These firms were charged with allowing Lincoln Savings and Continental to hide the truth about the real state of affairs underlying their financial data ([34]).

Keating could personally spend Lincoln’s money as fast as it could come in the Lincoln’s door. His lavish parities were the envy of the jet set and a literal cross section of Who’s Who would be present whenever it became known that Charlie was going to throw another bash. American Taxpayers, directly paid for spending of this nature, because Keating wrote a voucher for literally every nickel he ever spent and would turn them in and get re-paid back from Lincoln as a company expense. Luxury vacations, private jet planes and lavish lunches and dinners were only the start. Keating lived the good life on money illegally drawn down from Lincoln.

Keating also had a team of U. S. Senators to whom he had transferred $1.3 million in campaign contributions who would plead his case at the drop of a hat. Arizona’s DeConcini and former presidential candidate McCain, Cranston of California, Riegle of Michigan and former astronaut Glenn of Ohio became known as the “Keating Five” for their cozy relationship with him. He was also able to secure a job on the Bank Board as Commissioner to man that was substantially in debt to his institution. Talk about conflicts, it was the Bank Board that regulated Lincoln. He was also able to hire, now Chairman of the Federal Reserve to lobby for him to increase Lincoln’s “direct investments.” Eventually, Greenspan wrote a letter to a California bank regulator regarding Lincoln management stating: “seasoned and expert with a long and continuous track record of outstanding success in making sound and profitable direct investments.”

Keating remained arrogant until the end and once again we can sum up his attitude with a quote from the man himself:

“One question, among the many raised in recent weeks, has to do with whether my financial support in any way influenced several political figures to take up my cause. I want to say in the most forceful way I can: I certainly hope so.” ([35])

Keating collected other famous people in the same way he was able to draw in the senators, at his trial among the 120 letters were submitted by notables in his defense. One, from Calcutta; sent by Mother Teresa pleaded his case by pointing out how generous to the Indian poor he had been. Mother Teresa should have given some thought to the poverty his schemes had created in the United States. The money that was spent by the American people to rectify the damage caused by Keating could have fed every man, woman and child in the City of Calcutta for over a decade.

Their theory was that the Farm Home Loan Bank Board Chief, Edward Grey and other regulators were too tough on Lincoln. The ammunition for the theory was provided by an Arthur Young analysis, which gave Lincoln high operational marks. Incidentally, the author of the Arthur Young analysis, Jack Atchison, soon left for the employ of Mr. Keating at Lincoln at three times the salary ([36]). Congress asked a lot of question regarding Atchison’s dual role and in particular, Congressman Lehman was grilling an Arthur Young senior official, William L. Gladstone:

Congressman Lehman: Did anyone at Arthur Young have any contact with Mr. Atchison after he left and went to work for Lincoln?

Mr. Gladstone: Yes Sir.

Congressman Lehman: In the course of the audit?

Mr. Gladstone: Yes

Congressman Lehman: So he went from one side of the table to the other for $700,000 more?

Mr. Gladstone: That is what happened,

Congressman Lehman: And he—just tell me, what his role was in the audits…when he was on the other side of the table.

Mr. Gladstone: He was a senior vice-president for American Continental when he joined them in May 1988.

Congressman Lehman: Did the job he had there have anything to do with interfacing with the auditors?

Mr. Gladstone: To some extent, yes.

Congressman Lehman: What does “to some extent” mean?

Mr. Gladstone: On major accounting issues that were discussed in the Form 8-K, we did have conversations with Jack Atchison.

Congressman Lehman: So he was the person Mr. Keating had to interface with you in major decisions?

Mr. Gladstone: Him, and other officers of American Continental

It was unquestionable a conflict for Young to be interfacing with one of their former employees in their role as Independent Auditor for Lincoln. They had made some terrible mistakes and apparently didn’t know how to handle the resolution of them and were literally floundering. Kenneth Leventhal was asked to act as an independent forensic evaluator of what had occurred. They never mentioned anyone by name but there was no question to any one reading what they had to say as to who they felt the villains in matter really were.

“Seldom in our experience have we encountered a more egregious example of misapplication of generally accepted accounting principles? This association (Lincoln) was made to function as an engine, designed to funnel insured deposits to its parent in tax allocation payments and dividends. To do this, it had to generate reportable earnings. It created profits by making loans. Many of these loans were bad. Lincoln was manufacturing profits by giving money away.” ([37])

In their, take no prisoners report, Leventhal laid the blame where it should well have been placed. Arthur Young countered with the fact that, by number Leventhal had only check 15% of the real estate transactions that Lincoln had made and that under the circumstances, without getting a greater cross section, Leventhal retorted that their check covered approximately 50% of the transactions the Lincoln was involved in and there for Young was literally trying to blow smoke. In addition, they pointed out that of the transactions that they went over, something was literally wrong with every one.

Congressman Leach even found a problem with Young relative their approach with the investigating committee:

Congressman Leach: I am going to be very frank with you, that I am not impressed with the profession ethics of your firm vis-à-vis the United States Congress. Several days ago, my office was contacted by your firm, and asked we would be interested in questions to ask of Leventhal. We said. “Surely”. The question you provided were of an offensive nature. They were to request of Leventhal how much they were paid, implying that perhaps based upon their payment from the U.S. Government that their decisions as CPA’s would be biased. I consider that to be very offensive.

Now, in addition, one of the questions that was suggested I might ask of the Leventhal firm was: Could it be that their firm is biased because a partner in their firm did not make partner in your firm?

Mr. Gladstone: I do not know who contacted you and I certainly do not know how the questions were raised.

In effect, one of the senior partners of Young was indicating that he wasn’t sure that it was a Young employee or even whom it was that had provided the questions. Naturally, it would have extremely odd for the defense team representing Young not to have gone of the matters relating to Gladstone’s potential questions and answers from Congress. It was later determine of course, that it indeed was one of the people from Young that had provided the questions to the panel. Leach had time to reread the report and countered with:

Congressman Leach: I read that report very carefully, and I found no angry vengeful sweeping statement. But I did find a conclusion that Arthur Young had erred rather grievously. In any regard, what we are looking at is an issue that is anything but an accounting kind of debate. One of the techniques of Lincoln vis-à-vis the U. S. government was to attack the opposition. You are employing the same tactics toward Leventhal…. I think that is unprofessional, unethical and, based upon a very careful reading of their statement, irresponsible.

Now, I would like to ask you if you would care to apologize to the Leventhal firm.

Mr. Gladstone: First, Mr. Leach, I stated in my opening remarks that I believed that their report was general and sweeping and unprofessional, because (what) I would call unprofessional about it is the statement that looking at 15 transactions that therefore they would conclude that nothing Lincoln did had the substance—

Congressman Leach: I have carefully read their report, and they note that they have just been allowed to look at 15 transactions. They could not go into more detail, but they were saying that American Continental Corp. (Lincoln’s owner) batted 15 for 15, that all 15 transactions were unusual, perplexing, and in their judgment in each case breached ethical standards in terms of generally accepted accounting principles.

Your firm in effect saying, “We think that there may be some legal liabilities. There, we are gong to stonewall, an we are going to defend each and every one of these transactions.”

I believe that you are one of the great firms in history of accounting. But I also believe that big and great people and institutions can sometimes err. And it is better to acknowledge error than to put one’s head in the sand.

I think before our committee you have righteously done that.

Of particular interest is the fact that both the accounting and law firms involved had impeccable reputations both before and after the Lincoln debacle. If they had not cooperated, the repercussions of this felony would certainly have been less devastating. Keating, found guilty of felonies, is in prison and has declared bankruptcy. I am sure this has not assuaged his victims.

During the congressional hearing that had been enabled to review the thrift industry in general and Lincoln in particular so that it could be determined what went wrong. During the hearing Congressman, Jim Leach named everyone as guilty parties:

“I am stunned. As I look at these transactions, I am stunned at the conclusion of an independent auditing firm. I am stunned at the result. And let me just tell you, I think that this whole circumstance of a potential $2.5 billion cost to the United States taxpayers is a scandal for the United States Congress. It is a scandal for the Texas and California legislatures. It is a scandal for the Reagan administration regulators. And it is a scandal for the accounting profession.” ([38])

The Securities and Exchange Commission started an investigation on the various securities problems that had been inherent in the entire Lincoln mess. The biggest of the violations occurred when Lincoln set up offices in their facilities to push debt instruments which most people were led to believe were guaranteed by the government. Richard Breeden was particularly vocal about the fact that Arthur Young was not helping the SEC in any way with their investigation:

Commissioner Breeden: We subpoenaed the accountants (Arthur Young) to provide all of their work papers and their back up.

Congressman Hubbard: Do you know if they were forthcoming and helpful in helping you resole some of these questions, or helping the SEC resolve some of these questions?

Commissioner Breeden: No. I would characterize them as very unhelpful, very unforthcoming, and very resistant to cooperate in any way, shape or form. ([39])

Remember Lance Ito, the California Judge that received so much publicity during the O. J. Simpson trial. Ito also was the presiding judge in the Lincoln case. Well, Ito was no Keating fan and sentenced him to 10-years in jail for securities violations. In a concurrent case running in federal court, it must have been felt that Keating had gotten away with murder under Ito’s guidelines and they handed him an additional 12 years behind bars just for good measure.

But Keating was if anything, a gladiator, he appealed the Ito decision claiming that incorrect instructions were given to the jury. He was found to be correct and Ito was overturned on appeal. This same judge was simultaneously hearing an appeal of the federal case on the same grounds. If he overturned one, how could he not overturn the other? It seems that the Judges in both cases did not check to see if any of the jurors were aware of Keating’s conviction in the rival case and because some had been aware of what had gone on before, it was determined that Keating did not receive a fair trial.

By this time, Keating had already been jail waiting the outcome of his various appeals. The government announced that rather than see Keating walk, they were going to retry the case. When push came to shove, no one really wanted to do that whole thing all over again and just before the trial was to reconvene, both sides worked out a deal. Keating would agree that he had indeed done something terribly wrong ([40]) and for their part, the government would agree that he had been in jail long enough and would let him go.

Out of a total of 22-years in sentences that Keating had been given, he only served approximately 25% of that time in jail. In the meantime, everyone else involved with Keating suffered substantially in the derivative lawsuits that had been brought against one and all for helping to create the disaster. Three accounting firms were involved with Keating and Lincoln in one way or the other and the costs to all of them were not insubstantial. Young’s bizarre defense was a disaster waiting to happen and it did. They really came out looking like the villains in the case because of the hardball manner in which they conducted their defense. In the end, it did them little good and made the firm look like the villain, not an innocent party that had been set up by an ogre.

Silverado Banking Savings & Loan, Just Plain Lost Its Luster

The progeny of high-ranking officials benefit in strange ways from their father’s office. So it was with