Week 6 - Final Paper
Final Paper: Three Case Studies
Read the following case studies from the textbook and answer the discussion questions at the end of each:
• Anderson: An Obstruction of Justice? (pages C1-C4)
• GM: Running on Empty? (pages C11-C13)
• KPMG: How Many Firms? (pages C17-C19)
For each question, be sure to support your answers with facts, not just opinions. Be sure to properly cite sources according to APA style as outlined in the Ashford Writing Center (Links to an external site.). You must utilize a minimum of three scholarly sources, in which two must be from the Ashford University Library. One sentence responses are not sufficient. Each case should be approximately two to three pages, for a total of six to nine pages.
Writing the Final Paper
The Final Paper:
• Must be six to nine double-spaced pages in length (excluding title page and references page) and formatted according to APA style as outlined in the Ashford Writing Center (Links to an external site.).
• Must include a title page with the following:
o Title of paper
o Student’s name
o Course name and number
o Instructor’s name
o Date submitted
• Must address the topic of the paper with critical thought.
• Must utilize a minimum of three scholarly and/or peer-reviewed sources, in which two must be from the Ashford University Library, in addition to the text.
• Must document all sources in APA style as outlined in the Ashford Writing Center (Links to an external site.).
• Must include a separate reference page that is formatted according to APA style as outlined in the Ashford Writing Center (Links to an external site.).
Carefully review the Grading Rubric (Links to an external site.) for the criteria that will be used to evaluate your assignment.
Andersen’s attorneys, led by Rusty Hardin, defended Andersen against all charges brought by the government.
•The government’s case had fallen short of proving Andersen’s guilt or even proving that a crime had occurred.
•Duncan had shredded documents prior to any formal investigation (Andersen was not subpoenaed until November 8, 2001) and the elimination of unnecessary documents was a normal audit procedure.
•It was clearly sound business practice to consult with the corporate attorneys with regard to potential litigation and the firm’s rights and obligations with regard to that investigation. In fact, Duncan, at Temple’s request, had saved many documents that could have proved detrimental to Andersen.
•Hardin argued that Duncan was innocent and that the government had overstated its case against him in order to pressure him to cooperate with its investigation in exchange for a reduced sentence.
•While the prosecution focused on the part of the document retention policy that instructed auditors on the documents that could be destroyed, parts of the retention policy indicated which documentation was required to be retained in the audit files.
THE CASE GOES TO THE JURY
Although the prosecution and defense presentations were very contentious, possibly the most contentious part of the case focused on the instructions that Judge Melinda Harmon gave to the jury. The instructions hinged on the wording of the statute that makes it a crime to
knowingly use intimidation or physical force, threaten, or corruptly persuade another person…with intent to…cause that person to withhold documents from or alter documents for use in an official proceeding [emphasis added].3
Although both sides believed that the jury needed instructions that clarified the meaning of the statute in question, two issues were paramount in the argument concerning the instructions:
1.The phrase knowingly…corruptly persuade had been discussed at length. The government had contended that the word knowingly was not meant as a modifier of the term corruptly persuade. The jury had been instructed that
Even if the petitioner honestly and sincerely believed that the conduct was lawful, you may find the petitioner guilty.4
2.The government had contended that the word corruptly needed to be defined for the jury. Prior rulings in the 5th district court (the same court district that was trying the Andersen case) had stated that corruptly was
knowingly and dishonestly, with specific intent to subvert or undermine the integrity of the proceedings [emphasis added].
The government had insisted on excluding the word dishonestly and adding the word impede to the phrase “subvert and undermine.” The instruction provided to the jury had not included the word dishonestly and included the phrase “subvert, undermine, or impede” government fact finding.5
Having heard the testimony and been given these instructions, the jury convicted Andersen of obstruction of justice after deliberating for 10 days.
On May 31, 2005, in a unanimous decision, the U.S. Supreme Court overturned the Andersen conviction on the basis of flawed instructions to the jury. In writing the opinion, Chief Justice William Rehnquist cited the following arguments:
•Merely providing a person with information regarding a course of action cannot be construed as persuading another person…with intent to…cause that person to withhold documents.
•It is not necessarily corrupt in persuading another person…with intent to…cause that person to withhold documents. It may be proper for an attorney to persuade a client to withhold documents under attorney-client privilege from an investigation. In this circumstance, such persuasion would not be corrupt. Therefore, the withholding of documents from an investigation cannot by itself be presumed to be a corrupt action.
•Document retention polices are created to keep documents from being obtained by certain individuals and organizations, including the government. These policies are common in business and it is not wrongful for a manager to instruct employees to abide by such a policy.
•The term knowingly does modify the term corrupt both linguistically and per the intent of the statute. The jury instructions did not convey the requisite consciousness of wrongdoing that should be required for conviction.
•Substituting the term impede in place of dishonestly in the jury instructions removed the requirement that the action be with knowledge and forethought of wrongdoing. The term impede has a much broader concept. Anyone who innocently persuades another to withhold information might be considered to impede an investigation. Clearly, the term corruptly was included in the statute to exclude such innocent behavior from being consisted unlawful.
•A knowingly corrupt persuader cannot be someone who persuades others to shred documents under a document retention policy that was not enacted with regard to any particular proceeding in which those documents might be material. A series of events is not sufficient to indicate an intent to obstruct an investigation.
The headlines following the Supreme Court decision were telling:
“A Posthumous Victory,”
USA Today, June 1, 2005.
“Arthur Andersen’s Hollow Victory,” The Economist, June 4, 2005.
“Too Late for Andersen,” Legal Times, June 6, 2005.
“A Bittersweet Court Victory for Andersen,” Legal Times, June 6, 2005.
Although Arthur Andersen’s verdict had been overturned because of faulty jury instructions, it was far from a vindication that what Andersen had done was correct. In addition, such a decision came much too late to provide anything but a moral victory to Andersen’s former employees.
It is unlikely that the government will retry Andersen. First, there is little to gain in terms of either financial or other penalties. Andersen has already received the “death penalty” (and is no longer a viable entity), whether guilty or innocent. Second, should Andersen be retried and be found not guilty, the Department of Justice and the SEC would suffer severe blows to their reputation and receive a multitude of criticism from the business community. On the other hand, a retrial might be what the government needs to fend off criticism of being overzealous and overreaching in its prosecution of Andersen. But it does appear that the risks outweigh the rewards. Third, the government has received everything that it wanted with regard to Enron, WorldCom, and Andersen with the passage of the Sarbanes-Oxley Act. Most notably, a result of the Andersen case is a stricter document retention policy with more severe penalties for not following that policy.
It is interesting to note that many legal experts believe that the Department of Justice and the SEC took a vastly different attitude toward the 2005 tax-shelter problems of KPMG because of the lessons learned from the Andersen prosecution. Clearly, in the Andersen case, there had been no winners and the elimination of another international CPA firm would cause additional harm to innocent employees and create additional chaos in the business community.
Finally, in March 2007, a federal judge gave final approval to a $72.5 million settlement between Arthur Andersen and investors who sued the accounting firm over its role in Enron’s collapse.6 This finally put to rest the case of Andersen and Enron, but the repercussions may live on indefinitely.
1.Look up the term corrupt in the dictionary. What is its definition? Was corrupt appropriately applied to the actions of Arthur Andersen?
2.The issues that overturned the Andersen verdict were based on faulty jury instructions, not on whether Andersen was in fact guilty or innocent. Based on the information in this case and other information you know, do you believe Andersen violated the law?
3.Do you believe that the Supreme Court’s opinion overturning the lower court’s decision was appropriate?
4.Should the SEC and the Department of Justice have tried Andersen as a firm or should they have targeted specific individuals who had engaged in acts the two bodies believed to be unlawful?
5.Although Andersen’s conviction was overturned, do you believe that its employees acted in an ethical manner?
6.Comment on the actions of David Duncan and Nancy Temple. Which of these parties do you believe was more responsible for the Andersen saga?
7.The class action lawsuit against Andersen also named the Canadian Imperial Bank of Commerce, JPMorgan Chase, Citigroup, Merrill Lynch, and Credit Suisse Group as codefendants with Andersen. Why would the plaintiffs name so many entities in their lawsuit? Merrill Lynch and Credit Suisse asked a U.S. appeals court to rule that the complaint should not have been certified as a class action suit. Why would these entities make such a claim?
GM: Running on Empty?
Founded in 1908, General Motors Corp. (GM) is truly an iconic American corporation. From 1931 through 2008, GM was the world’s largest automobile manufacturer, and in 1955, it became the first company in any industry to report more than $1 billion in revenues. GM’s market share peaked at 51 percent in 1962. GM’s domination in the market was such that many recommended the company be subject to scrutiny under antitrust laws. In 1971, former President Lyndon Johnson made the statement “now what’s good for General Motors really is good for America.”1
GM’s net income reached an all-time high of $6.7 billion in 1997, and the automaker continued to generate positive net income through 2004. In 2005, things began to change. GM reported a net loss of more than $10 billion and continued to post losses through 2008, with a loss of almost $31 billion in that year. (GM’s cash flow from operations in 2008 was a negative $12 billion.) A summary of various measures of GM’s financial condition for the six-year period from 2003 through 2008 is presented in GM Exhibit 1.2
Because of concerns with the ultimate impact of GM’s financial struggles on the world economy, GM received $13.4 billion in government loans in December 2008. President Barack Obama’s administration pledged interim financing to allow GM to develop a restructuring plan, requested then-CEO Rick Wagoner to resign, and announced a plan to replace at least 6 of the 12 members of GM’s board of directors. All of these events occurred in a market in which the economic conditions sharply decreased demand for automobile purchases. Not surprisingly, GM’s stock reached a low (at that time) of $1.45 per share on March 6, 2009. (With one brief exception, GM’s stock traded between $30 per share and $82 per share between 1983 and 2008.) GM’s high, low, and closing stock prices for the period 2003–2008 are summarized in GM Exhibit 2.
In its March 4, 2009, report on GM’s financial statements, GM’s auditors (Deloitte & Touche) concluded that GM’s financial statements were fairly presented in conformity with GAAP.
GM EXHIBIT 1 Summary of Financial Information: General Motors Corp. (amounts in millions)
Source: General Motors Corp. 2003–2008 10-K reports.
GM EXHIBIT 2 Annual High, Low, and Closing Stock Prices: General Motors Corp.
Source: Wharton Research Data Services.
However, Deloitte expanded its report to include the following paragraph to recognize uncertainties regarding GM’s ability to continue as a going concern:
The accompanying consolidated financial statements for the year ended December 31, 2008, have been prepared assuming that the Corporation [GM] will continue as a going concern. As discussed in Note 2 to the consolidated financial statements, the Corporation’s recurring losses from operations, stockholders’ deficit, and inability to generate sufficient cash flow to meet its obligations and sustain its operations raise substantial doubt about its ability to continue as a going concern. Management’s plans concerning these matters are also discussed in Note 2 to the consolidated financial statements. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.
In April 2009, GM’s Chief Executive Officer Frederick “Fritz” Henderson (who succeeded Rick Wagoner) created a restructuring plan to save GM. Under this plan, the debt owed to unsecured bondholders, the United Auto Workers, and the U.S. government (which totaled $74.4 billion across the three groups) would be reduced by $44.6 billion in exchange for a 99 percent interest in the emerging company. In addition, the terms of this plan called for the closure of 42 percent of GM’s dealers.3
On June 1, 2009, the once unthinkable happened: GM filed for Chapter 11 bankruptcy. Under the terms of the bankruptcy plan, two entities were created: an “old GM” (subsequently named Motors Liquidation Company), a public company that owns four brands in the process of being phased out (Hummer, Saab, Pontiac, and Saturn), and a “new GM,” a private company that is majority owned by the U.S. government (a 60% stake), with the Canadian government (11.7%), United Auto Workers (17.5%), and GM’s unsecured bondholders (10%) owning large minority stakes. The new GM (known as General Motors Co .) received the Buick, Cadillac, Chevrolet, and GMC brands. General Motors Co. emerged from bankruptcy and began its operations on July 10, 2009, just 40 days after the filing. A brief profile of GM (the combined entity prebankruptcy) and General Motors Co. (the new GM that emerged postbankruptcy) is shown in GM Exhibit 3.4
A BOOST FOR THE AUTO INDUSTRY
On July 1, 2009, the U.S. government announced the Car Allowance Rebate Program (popularly known as the “Cash for Clunkers” program) to provide incentives for the automobile industry. Initially, $1 billion was appropriated for this program, but overwhelming demand from consumers resulted in an additional $2 billion allocation when the original funds were exhausted. More than 690,000 transactions were rebated under this program, 17.6 percent of which were for General Motors Co. automobiles.5 Despite this program, GM’s 2009 retail sales were down 17 percent from 2008.
In November 2010, GM returned to public company status with an initial public offering that raised $23.1 billion, one of the largest such offerings in the history of the United States6; GM’s stock price closed at $34.19 that day. Deloitte & Touche’s opinion on GM’s 2010 financial statements (issued on March 1, 2011) concluded that GM’s financial statements were presented in conformity with GAAP and made no reference to the going-concern uncertainties that GM had previously faced. GM has returned to profitability with reported net income (before noncontrolling interests and preferred dividends) of $6.2 billion, $9.2 billion, and $6.2 billion in 2010, 2011, and 2012, respectively; however, as of mid-2013, its stock price had risen only slightly above its public offering price, to $34.96 per share. On June 5, 2013 (less than four years after its bankruptcy), GM rejoined the S&P 500, replacing Heinz following its acquisition by Berkshire Hathaway.
GM EXHIBIT 3 Profile of General Motors Corp. and General Motors Co.
General Motors Corp. (prebankruptcy) General Motors Co. (postbankruptcy)
Debt (billions) $176 $48
Employees 91,000 68,500
Brands 8 4
Dealers 5,900 3,600
Manufacturing plants 47 34
1.Reviewing GM’s financial information in GM Exhibit 1 and its stock price in GM Exhibit 2, when do you first see signs of GM’s impending financial distress?
2.In referencing professional standards, what factors should auditors consider in evaluating potential going-concern uncertainties?
3.Considering your response to questions 1 and 2, do you believe that the going-concern uncertainty was warranted? Do you believe that Deloitte & Touche should have issued a going-concern opinion prior to 2008?
4.What economic factors existing in the United States during 2008 might have accelerated Deloitte & Touche’s decision to issue an audit opinion modified to disclose going-concern uncertainties?
5.Do you believe that the events immediately following GM’s bankruptcy alleviated the concerns that led to the issuance of the going-concern uncertainty? What issues would auditors need to consider in evaluating the ability of General Motors Co. (the new GM) to continue as a going concern?
6.Many companies believe that a going-concern opinion is a self-fulfilling prophecy (that is, when a company receives a going-concern opinion, customers will not purchase products with warranties, suppliers will not provide short-term credit, and investors and creditors will not invest or loan). Would GM’s going-concern opinion influence your decisions regarding either purchasing a car from GM or investing in GM’s stock? Is a going-concern a self-fulfilling prophecy?
KPMG: How Many Firms?
How many major accounting firms are needed to provide companies sufficient choice? Because of their scale, expertise, and international presence, the world’s largest corporations have traditionally relied on the largest accounting firms to conduct their audits. As late as 1988, the “Big Eight” firms (Arthur Andersen & Co., Arthur Young & Company, Coopers & Lybrand, Deloitte Haskins & Sells, Ernst & Whinney, KPMG, Price Waterhouse & Co., and Touche Ross & Co.) dominated the market for audit services. In 1989, mergers between Ernst & Whinney and Arthur Young (to form Ernst & Young) and Deloitte Haskins & Sells and Touche Ross (to form Deloitte & Touche, Deloitte) reduced choices to six providers. The merger of Price Waterhouse and Coopers & Lybrand in 1998 as PricewaterhouseCoopers (PwC) limited them to five.
Although a company’s options with respect to the choice of an independent auditor were reduced by almost 50 percent, not until the Justice Department’s dissolution of Arthur Andersen in 2002 were concerns raised about the lack of choices in the market for audit services and its impact on the competitiveness of the industry. (Arthur Andersen’s verdict was overturned by the Supreme Court in 2005, but its partners and personnel had pursued other employment opportunities.)
The gulf between the Big Four and the next tier of accounting firms can be best illustrated by comparing KPMG (the smallest of the Big Four, in terms of revenues) with McGladrey the fifth-largest accounting firm. In 2012, KPMG’s revenues from audit and assurance services totaled $2.3 billion, compared to $589 million at McGladrey.1 Viewed from a consumer’s standpoint, in 2012, Big Four firms audited all Fortune 100 companies and all but 6 of the Fortune 500 companies.2
In addition to a smaller set of large accounting firms, public companies are constrained by provisions of the Sarbanes-Oxley Act. In an effort to enhance auditor independence, Sarbanes-Oxley prohibits auditors from providing various types of nonaudit services to their audit clients. This prohibition was in response to the large shift of accounting firm revenues from primarily audit revenues to revenues for other services.3 For example, in 1975, the percentage of total revenues from the Big Eight firms derived from audit services ranged from 62 percent (Touche Ross & Co.) to 76 percent (Price Waterhouse & Co.); in 2000, this same percentage ranged from 31 percent (Deloitte & Touche) to 45 percent (KPMG).4
As a result of Sarbanes-Oxley, public companies have engaged other Big Four firms for nonaudit services. As just one example, at one time, the Big Four firms provided Wabtec Corp. auditing (Ernst & Young), internal control testing (Deloitte & Touche), acquisitions advising (KPMG), and tax services (PricewaterhouseCoopers). If Wabtec decided to change auditors yet retain a Big Four firm, it would need to consider the effect of these services on the independence of its new auditor. A survey by J.D. Power & Associates of the 400 companies with more than $1 billion in revenue revealed that 55 percent of these companies are using more than one Big Four firm to provide various types of services (including audit services).5
The bottom line is that two independent developments (a smaller number of international accounting firms and Sarbanes-Oxley’s limitations on the nonaudit services that can be provided by a company’s auditors) have significantly impacted companies’ choices of auditors. This dilemma can be best reflected by the experiences of two large organizations.
First, in 2005, Intel Corp. considered proposals for its audit engagement from all four firms. It retained Ernst & Young, which has audited Intel’s financial statements for more than 30 years. This decision was largely driven by the nonaudit service provided to Intel by the other Big Four firms. Cary Klafter, Intel’s corporate secretary, noted that “because there are only a limited number of large multinational audit firms that do the kind of work that we need, if we were to switch audit firms, all sorts of dominos would fall.”6
Second, when Fannie Mae dismissed KPMG as its auditor in the wake of an accounting scandal, its choices for a successor were slim: Deloitte & Touche had been advising the federal government in its probe of Fannie Mae, Ernst & Young had been providing consulting services to Fannie Mae’s audit committee responding to the probes related to the scandal, and PricewaterhouseCoopers audited Freddie Mac, a major competitor.7
Could something happen to limit companies’ choices even further?
From 1996 through 2002, KPMG received $124 million in tax consulting fees from promoting tax shelters that allowed individuals and corporations to improperly avoid more than $1.4 billion in federal taxes.8 E-mail messages obtained and released by the Internal Revenue Service indicated that KPMG officials were aware that the tax shelters were questionable.
As one example, a shelter referred to as bond-linked issue premium structures (BLIPS) created $5 billion in tax losses for investors. Under this shelter, clients would purchase foreign currency from offshore banks with funds borrowed from those same banks only to sell the currency back to the same bank a few months later. These investments were presented to the Internal Revenue Service as seven-year investments.9 Other shelters in question carried similar names such as FLIP, OPIS, and SOS.
On August 26, 2005, KPMG admitted to criminal tax fraud and agreed to a payment of $456 million in penalties (an average of $300,000 per KPMG partner); the government agreed to deferred adjudication and, in January 2007, dismissed all criminal charges against the firm. Subsequently, Judge Lewis Kaplan of the U.S. District Court for the Southern District of New York dismissed indictments against 13 of 16 former KPMG partners and, on December 18, 2008, two of the remaining three partners were convicted on multiple counts of tax evasion (the remaining partner was acquitted).10
In the midst of this activity, federal prosecutors indicted four current and former partners of Ernst & Young on similar charges. The shelters designed and sold by these partners brought Ernst & Young $120 million in fees. Those familiar with the matter do not expect that the firm itself will face criminal charges in this matter;11 however, on May 8, 2009, four current and former E&Y executives were convicted.
KPMG has avoided the fate of Arthur Andersen: dissolution. However, the KPMG case has raised numerous questions about the future of the accounting profession if the small number of international accounting firms should become even smaller. For example, the Securities and Exchange Commission discussed various actions to assist companies in changing auditors if KPMG was indicted, including allowing companies to seek waivers to the stricter independence rules on a case-by-case basis and allowing KPMG to continue to perform audits if it were indicted. An unidentified SEC official indicated that “we have scenarios in place for any eventuality that could come out of this.”12 In addition, prior to the settlement, Deloitte & Touche, Ernst & Young, and PricewaterhouseCoopers reportedly requested that their partners not solicit current KPMG clients.13
1.Do professional standards allow a company’s auditors also to provide tax services and retain their independence?
2.How have provisions of the Sarbanes-Oxley Act limited a public company’s choice of auditors?
3.What are some of the advantages and disadvantages of permitting auditors to provide nonaudit services (such as tax services) to clients?
4.What is the impact of a smaller number of major international accounting firms on public companies?