Read Microsoft PowerPoint - NHS Enron text version

Governance in the NHS

National Conference 2002 Birmingham

Enron & co - ethics meltdown

Root Causes and Impacts of Corporate Failures

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Topics

· What happened · The impact on trust in the capitalist system · Root causes and conspiracies

­ Ethics, Ambition, Complexity

· Aided and abetted by ....

­ Other conspirators

· Reaction

PDK

Enron - August - November 2001

Nov. 8 - Analysts are still recommending Enron as a "Buy"

Nov 28 - CSFB analyst still recommending Enron as a "Strong Buy"

PDK

Suspicion spreads

· · · · · · ·

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Tyco Global Crossing Cendant General Electric Williams Cos. Elan IBM

"You walk into the kitchen and you see a cockroach -you are pretty confident that it is not the only one around."

John Hendricks, VP State Street Global Markets

Just recently

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Impact on markets

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Impact on new investment

In 1999, the median age of companies in new stock offerings was 4 years. Now it's 15.

NYT, May 19 2002

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Impact on Ordinary Investors

"I've worked two jobs for the last 12 years and put the maximum into my 401K. Now I've lost almost half of it in 7 months."

PDK Taxi-driver in Washington DC

Impact on State Pension Funds

PDK

Enron root causes and conspiracies

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Management

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Root causes lie in leadership and the control environment

1 Ethics 2 Ambition 3 Complexity

WSJ - Feb 15/02

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The ethics of making your problems disappear

· The magic team - bankers and accountants

­ CSFB Structured Products Group ­ "Fastow's field marshals"

· · · ·

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Invent new structures Monetize all non-performing assets Sell them to the "partnership of the month" Then " lean on Andersen"

The ethics of Special Purpose Entities (SPEs)

· Partnership or other vehicle designed to offload Enron debt and increase revenue · Sell non-performing assets to the SPE at high value: reduce debt, increase cash flow · Guarantee the SPE using Enron stock

"All they were doing was looking at GAAP and FASB documents and saying, "Well this is what it says," and then finding the most byzantine way to get around the law so that it's still legal but violating the spirit." Financial Times, quoting former Enron employee

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Effect of Chewco and LJM1

· · · · · $ Millions Debt reductions Revenue increases From 2 of the SPEs There were over 3500 SPEs by the end

300 200 100 0 -100 -200 -300 -400 -500 -600 -700 -800

Debt Revenue

1997

1998

1999

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2000

The ethics of electricity Get Shorty and Fat Boy

· WASHINGTON, May 15 -- Enron lawyers

alerted senior company executives in October 2000 to trading strategies that Enron was using in the California electricity market, and concluded in December 2000 that the tactics were "potentially criminal." Only then did the company order the maneuvers stopped, according to Senate testimony today.

NYT, May 16, 2002

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Ambition

We are Number 7 now [in the Fortune 500]. I believe within two years we will be Number 1.

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Complexity overload

· 3500 SPEs created · Can't see real picture · Begin to break already "bent" accounting rules · SPEs supported by Enron stock guarantees with pre-set "triggers" · Stock price declining · BBB+ rating very thin

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"What I can't believe is that anyone ever got comfortable when you put all of this stuff together. These partnerships clearly posed a material risk for the company." Financial Times, quoting a banker, March 1,2002 "If this thing hits $20 you better run for the hills." FT, quoting a CSFB banker

Enron's management tale is not a new story

· · · · IOS Savings & Loans Equity Funding 1, 2, 3 or a combination

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3.Complexity

2 Ambition

1 Ethics

Aided and Abetted by .....

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The Collaborators

· · · · · · ·

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Accountants Bankers Stockbroker Analysts Lawyers Government Directors Other "bright sparks"

How a buck passes

· Larry King: "But really, as the CEO, shouldn't you have known about these issues?" · Skilling: "Well, Larry, CEOs don't have time to get into all the details. That's why they rely on lawyers and accountants."

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In practice, former employees say, they often bullied Andersen into accepting their [accounting] treatments. Financial Times

...creative efforts to circumvent accounting principles through the complex structuring of transactions that lacked fundamental economic substance.

External Auditors

In virtually all of the transactions, Enron's accounting treatment was determined with extensive participation and structuring advice from Andersen, which Management reported to the Board.

PDK

Report of the Special Investigation Committee the "Powers Report"

Andersen client accounting frauds in the late 1990s

· Colonial Realty · Sunbeam ($110M) · Baptist Foundation of Arizona ($217 M) · Waste Management

Globe and Mail -June 20, 2001

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After Waste Management fine, AA signs SEC agreement to avoid wrongdoing

· In the Waste Management investigation SEC finds many documents in AA's own files indicating they knew of fraud - PAJEs · Andersen's new policy:- ensure all nonessential documents are destroyed post audit

In three days [in Houston], 26 trunks of documents as well as 24 boxes were shredded .... Simultaneously, there was a threefold increase in the volume of e-mail deletions. New York Times

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Andersen's new document policy

Delete

SEC on Auditor Independence

I fear that the audit process, long rooted in independence and forged through professionalism, may be diminished perhaps even sacrificed in the name of more financial and commercial opportunities.

Chairman Arthur Levitt US Securities & Exchange Commission Remarks to Panel on Audit Effectiveness of the Public Oversight Board October 7, 1999

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Sweethearts

· After Andersen signed off on ..the 1993 financial statements...Mr Buntrock rewarded Andersen by granting a $3.7 million consulting contract to ..Andersen Consulting [for] an 11 month "strategic review" · The review, which one former WM director described as a "boondoggle", was abandoned after 11 months

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Details from SEC suit as quoted by WSJ, March 27, 2002

Is conflict of interest the main problem?

· If so, then Enron is only the tip of the iceberg

PDK

Auditor conflict at Enron Tiny by Comparison

Enron (AA) AOL TW (E&Y) Delphi (D&T) Sprint (E&Y) Motorola(KPMG) GE (KPMG) JP Morgan(PWC) 0% 20% 40% 60% 80%

52 million 59 58 66 66 104 105

Audit IT Consult

100%

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Source - Wall Street Journal and Proxy Filings

Banks helpful - to a fault!

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Wall Street Journal

Spreading the deception

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Wall Street Journal

Why the little investor has fled

· ML tells the public "BUY" but internal memos call stock "junk" or "piece of crap" · Big companies give analysts information three days before public announcements · Banks give Ebbers et al. big IPO rewards none for the little guy · No longer sees external audits as trustworthy

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G&M - Jan 17/02

Directors' Responsibility

· · · · Ask the tough questions Face up to the liability Demand enough time Don't be afraid to say you don't understand · Report on your review of control effectiveness · Wake up! - existing board oversight is hopelessly outgunned

WSJ - Jan Enron's Board29/02 voted to twice suspend Enron's conflict of interest guidelines to allow the creation of Special Purpose Entities

Globe & Mail - November 9, 2001

PDK

Other "bright sparks" now extinguished

Fastow Rigas Kozlowski Sullivan

Enron Adelphia Tyco WorldCom

Ebbers CEO WorldCom

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Waksal CEO IMClone

Reaction

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US Congress

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A flurry of activity in the USA

Merrill Lynch pays $100 million fine to NY Officials of 14 States Pledge Protection of Pension Assets I.B.M. to Purchase [PWC] Consulting Group for $3.5 Billion

PDK

Bush Signs Broad Changes in Business Laws NASD Suspends 2 Executives of First Boston Hard-liners proposed to head new Board on Accounting New York Times

Sarbanes-Oxley

· Independent Public Company Accounting Oversight Board · SEC Budget Increase · Audit firms' conflict of interest stopped dead · Audit Committees strengthened

PDK

Sarbanes-Oxley

· Senior Management Code of Ethics · Management assess, report on control annually · Insider trading controls · Stiff penalties, prison for offenders · Whistleblowers protected

PDK

Concerns re Sarbanes-Oxley

· Emphasis on financial accounting expertise · What is Control? · Provenance - some supporting politicians are the same ones who vocally defeated earlier reforms (Tauzin, Lieberman, Oxley)

UPDATE Oxley has successfully lobbied to replace the hard-line reform candidate for the Accounting Oversight Board.

PDK

New "Regulation" in Canada

· Saucier Report (November 2001) · Corporate Public Accountability Board · CICA (www.cica.ca)

­ Accounting Standards Board (SPE and G'tee) ­ Public Interest and Integrity Committee (ED) ­ Exposure Draft on Independence Standards

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IIA on the Auditor's Role in Governance

· · · · Governance & Organizational Culture Shared Responsibility for the Organization Internal Auditing as Ethics Advocate Assessment of the Organization's Ethical Climate

IIA Practice Advisory 2130

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Your Ethics

(based on ESA voting responses)

PDK

Acknowledgment of Sources

· Thanks are due to the following sources quoted in this presentation:

­ ­ ­ ­ ­

PDK

The Economist Financial Times Globe & Mail New York Times Wall Street Journal

Contact Information

Paul Makosz Chief Executive Officer PDK Control Consulting International Ltd. PO Box 22310 Bankers Hall Calgary, Alberta, Canada T2P 4J1 Tel: 403-571-0999 Web: www.csa-pdk.com Fax: 403-571-0991 E-Mail: [email protected]

PDK

Information

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