SouthAmerica: Arthur Andersen once one of the "Big Five" accounting firms among PricewaterhouseCoopers, Deloitte Touche Tohmatsu, Ernst Young, and KPMG died a sudden death during the Enron fiasco.
Now it looks like that another one of the world's leading accounting organizations one of the "Big Four" – this time Ernst Young also will die a quick death.
Common sense tells me that only fools would trust the Ernst Young's audited information, since they are as good as garbage.
Here are a few examples of Ernst Young's audited garbage information that they certify for public consumption:
“The case against Lehman Brothers”
60 Minutes - August 19, 2012
Steve Kroft investigates the collapse of Lehman Brothers, which triggered a chain reaction that produced the worst financial crisis and economic downturn in 70 years.
(CBS News) It's hard to overstate the enormity of the 2008 collapse of Lehman Brothers. It was the largest bankruptcy in history; 26,000 employees lost their jobs; millions of investors lost all or almost all of their money; and it triggered a chain reaction that produced the worst financial crisis and economic downturn in 70 years.
Yet four years later, no one at Lehman has been held responsible. Steve Kroft investigates the collapse of Lehman Brothers: what the SEC did and didn't know about the firm's finances, the role of a top accounting firm, and why no one at Lehman has been called to account.
On Sept. 15, 2008, Lehman Brothers, the fourth largest investment bank in the world, declared bankruptcy -- sparking chaos in the financial markets and nearly bringing down the global economy. It was the largest bankruptcy in history -- larger than General Motors, Washington Mutual, Enron, and Worldcom combined. The federal bankruptcy court appointed Anton Valukas, a prominent Chicago lawyer and former United States attorney to conduct an investigation to determine what happened.
Included in the nine-volume, 2,200-page report was the finding that there was enough evidence for a prosecutor to bring a case against top Lehman officials and one of the nation's top accounting firms for misleading government regulators and investors. That was two years ago and there have been no prosecutions. Anton Valukas had never given an interview about his report until we broadcast this story in April of this year.
Steve Kroft: This is the largest bankruptcy in the world. What were the effects?
Anton Valukas: The effects were the financial disaster that we are living our way through right now.
Steve Kroft: And who got hurt?
Anton Valukas: Everybody got hurt. The entire economy has suffered from the fall of Lehman Brothers.
Steve Kroft: So the whole world?
Anton Valukas: Yes, the whole world.
When Lehman Brothers collapsed, 26,000 employees lost their jobs and millions of investors lost all or almost all of their money, triggering a chain reaction that produced the worst financial crisis and economic downturn in 70 years. Anton Valukas' job was to provide the bankruptcy court with accurate, reliable information that the judges could use to resolve the claims of creditors picking over Lehman's corpse.
Steve Kroft: Had you ever done anything like this before?
Anton Valukas: I've never done anything like Lehman Brothers. I don't think anybody else has ever done anything like Lehman Brothers.
Steve Kroft: So your job, I mean, in some ways, your job was to assess blame?
Anton Valukas: Our job is to determine what actually happened, put the cards face up on the table, and let everybody see what the facts truly are.
Valukas' team spent a year and a half interviewing hundreds of former employees, and pouring over 34 million documents. They told of how Lehman bought up huge amounts of real estate that it couldn't unload when the market went south -- how it had borrowed $44 for every one it had in the bank to finance the deals -- and how Lehman executives manipulated balance sheets and financial reports when investors began losing confidence and competitors closed in.
Steve Kroft: Did these quarterly reports represent to investors a fair, accurate picture of the company's financial condition?
Anton Valukas: In our opinion, they did not.
Steve Kroft: And isn't that against the law?
Anton Valukas: It certainly, in our opinion, was against civil law if you will. There were colorable claims that this was a fraud, yes.
By colorable claims Valukus means there is sufficient evidence for the Justice Department or the Securities and Exchange Commission to bring charges against top Lehman executives, including CEO Richard Fuld, for overseeing and certifying misleading financial statements, and against Lehman's accountant, Ernst and Young, for failing to challenge Lehman's numbers.
Anton Valukas: They'd fudged the numbers. They would move what turned out to be approximately $50 billion of assets from the United States to the United Kingdom just before they printed their financial statements. And a week or so after the financial statements had been distributed to the public, the $50 billion would reappear here in the United States, back on the books in the United States.
Steve Kroft: And then the next financial statement, they would move it overseas again, and file the report, and then move it back?
Anton Valukas: Right.
Steve Kroft: It sounds like a shell game.
Anton Valukas: It was a shell game. It was a gimmick.
Lehman misused an accounting trick called Repo 105 to temporarily remove the $50 billion from its ledgers to make it look as though it was reducing its dependency on borrowed money and was drawing down its debt. Lehman never told investors or regulators about it.
Steve Kroft: This is really deception to make the company look healthier than it was?
Anton Valukas: Yes.
Steve Kroft: Deliberate?
Anton Valukas: Yes.
Steve Kroft: How are you so sure of that?
Anton Valukas: Because we read the emails in which we observed the people saying that they were doing it. We interviewed the witnesses who wrote those emails, or some of those emails, and asked them why they were doing it, and they told us they were doing it for purposes of affecting the numbers.
Steve Kroft: Do you think that Lehman executives knew that this was wrong?
Anton Valukas: For some of 'em, certainly. There was concerns being expressed by-- at high levels about whether this is appropriate, what happens if the street found out about it. So, you know, there was a concern that there's a real question about whether we can do this, whether this was right or not.
One of those people was Matthew Lee who had been a senior executive at Lehman and the accountant responsible for its global balance sheet. Lee was one of the first to raise objections inside Lehman about the accounting trick known as Repo 105.
Matthew Lee: It sounded like a rat poison, Repo 105, when I first heard it. So I investigated what it was, and I didn't like what I saw.
...But Lehman executives couldn't ignore the letter and asked their accountants from Ernst and Young to interview Matthew Lee.
Anton Valukas: And in those interviews, we have the notes -- which are part of the report -- he says very specifically $50 billion, Repo transactions, moving money off the balance sheet at quarter end. So our conclusion was Ernst and Young certainly knew it as of that time, and did nothing with it.
Valukas says Ernst and Young was legally bound to make sure that Lehman's audit committee and its board of directors knew about Lee's allegations of unethical and unlawful accounting practices. But they never did.
...Ernst and Young, Lehman's accounting firm is now being sued by New York State for aiding and abetting a fraud.
Note: You can read the entire transcript of the program where the video of that program is located.
This story appears in the May 7 edition of Forbes magazine on page 150.
Zynga, Facebook and Groupon all use an independent auditor that is simultaneously inventing the rules for social media accounting.
Somewhere, Arthur Andersen is shuddering.
For 26 million digital farmers working their fields and crops on Zynga’s popular game FarmVille, obtaining a virtual tractor, seeder or harvester can be transformative. A make-believe tractor, for example, allows you to plow four plots at a time. It’s the kind of productivity that laptop-bound farmers dream of.
The problem is that earning enough FarmVille currency to afford heavy farm equipment takes time. But like other social gaming companies, Zynga allows users to speed up the process by converting real dollars from their credit card and PayPal accounts into the FarmVille currency used to buy virtual goods. A hot rod tractor, for example, costs 55 in Farm Cash, which translates into $10 in real U.S. money.
For Zynga, which also owns CityVille, Zynga Poker, Mafia Wars and Words With Friends, virtual tractor sales are big business. The fledgling San Francisco company likely sells millions of tractors each year (that compares with 190,000 real tractors sold in 2011 in the U.S. and Canada). Sales of virtual goods, from FarmVille hay to Mafia Wars assault rifles, accounted for nearly all of Zynga’s $1.1 billion in 2011 revenues and 12% of revenue for Zynga’s distributor, Facebook.
Which makes it very helpful that both have the same friend in the accounting business: Ernst & Young, the public auditor for Zynga and Facebook.
Ernst & Young wrote the book on accounting for virtual goods, literally. The third-largest accounting firm behind PricewaterhouseCoopers and Deloitte, it leads its rivals in the technology and burgeoning social media space. Neither the Financial Accounting Standards Board nor the Securities & Exchange Commission has issued rules for the likes of livestock love potions and virtual harvesters, so an E&Y document (updated this past March) lays out three revenue-recognition models it deems consistent with Generally Accepted Accounting Principles.
Such publications are well worth E&Y’ s effort, since its “Strategic Growth Markets” consulting unit helps companies develop their financial systems, controls and accounting policies well before they are ready to come public. Which is potentially problematic. A firm that consults on byzantine accounting rules for unusual revenue streams and also offers “independent” auditing services for the same companies?
The ghosts of Arthur Andersen and Enron shudder.
Sarbanes-Oxley, of course, was supposed to fix such conflicts. But just as it handcuffed the IPO market, Sarbox blew it here, too.
While it wisely bans an accounting firm from simultaneously auditing a public company and selling it most consulting services the toxic combo that torpedoed Arthur Andersen and thousands of Enron’s innocent shareholders—it doesn’t prevent an accounting firm from first consulting on technical and internal accounting issues for a start-up and later, when that emerging company is getting ready to go public, segueing into a role as independent auditor, potentially auditing its own work.
So did E&Y consult for Facebook and Zynga before becoming their independent auditor? It won’t say. Stephen Blowers, E&Y’s Americas Vice Chair of Independence, does say that before an audit client goes public his team conducts an extensive review of all the work E&Y did for the company during the three years of audited statements in the IPO, as well as an extra year before that, to make sure it has complied with all the SEC’s auditor independence rules. “We are confident of our independence,’’ he adds.
Facebook, Zynga and Groupon, another E&Y auditing client that was recently scrutinized for its aggressive accounting, also wouldn’t say what consulting E&Y did for them before becoming their auditor. And you won’t find it in SEC filings; it doesn’t ever have to be disclosed. “The situation does not instill confidence that a fresh set of eyes have looked at the numbers,” says former SEC chief accountant Lynn Turner.
There are hints. In its 2011 annual report, Zynga quotes from E&Y’s guide liberally and verbatim in explaining why it recognizes revenue from the sale of virtual “durables” like FarmVille tractors at a slow pace, and dollars from the sale of “consumables” like energy immediately.
The common denominator in Ernst & Young’s new social gaming accounting rules appears to be that significant discretion is left up to management when it comes to the timing of revenue recognition. E&Y basically gets to make up the rules in this brand-new area as it goes along. And those rules drive the stock price.
Here’s how the virtual-goods accounting game is played. If you buy and hold Facebook credits (used to buy virtual goods in games on Facebook) Facebook treats the purchase as deferred revenue the same way a retailer would book the sale of a gift card until you spend your credits. When you buy FarmVille’s hot rod tractor, you use your Facebook credits or charge $10 (which, unseen to you, buys 100 Facebook credits that are converted to 55 in Farm Cash).
Facebook sends $7 to Zynga and keeps 30% $3 as a processing fee, moving that $3 from deferred revenue into current revenue.
When does Zynga get to recognize its $7 in revenues? FASB doesn’t have social media standards, but its broader guidelines hold that revenue should not be recognized until it is both realized (or realizable) and earned. In other words, even if a company has cash in hand, it can’t be counted as current revenue until the company has delivered the product or service it’s being paid for.
E&Y has stepped into the void, proposing three different models for social gaming companies to pick from: game-based, in which revenue is recognized very slowly, over the life of the game; user-based, a faster scheme that lasts over the time a typical user sticks with the game; and speedy item-based, rooted on the properties of specific virtual goods. Using the last method, Zynga recognizes revenues from “consumable” virtual items like energy immediately and revenues from “durable” ones like tractors over the time a player is projected to stick with a game.
When you think about it, this makes sense. But selecting an accounting method is only part of the game here. All these revenue-recognition methods are dependent on management estimates of the life of a game, a customer or a virtual item that’s wide latitude to interpret consumer behavior in a new and fast changing business. Tweaking estimates can make a big difference to the bottom line.
For example, in its fourth amended registration statement, filed with the SEC in October of 2011, Zynga noted that during the first half of last year it estimated the blended average paying player life for a game as 15 months, down from 19 months a year earlier. The shorter player life increased GAAP revenue for the six months by $27.3 million, turning a loss for the six months ended June 30, 2011 into a net profit of $18.1 million. Well-timed: This change came just before Zynga went public in mid-December at $10 a share.
“From our perspective, the inconsistent application of useful lives and resulting depreciation does more to confuse the economics of the business,” says Rick Summer, senior equity analyst at Morningstar, “and it is also a poor proxy for cash flow.”
Summer prefers an entirely different, non-GAAP metric, “bookings,” which Zynga itself touts in its press releases. It counts all revenue from virtual goods sales at the time the player purchases them, providing investors a read on the pulse of business momentum regardless of the timing of revenue recognition. For 2011 Zynga’s bookings were a record $1.16 billion, up 38% year-over-year—producing a non-GAAP net income of $303 million. Pay no attention to Zynga’s official net loss of $404 million for 2011, as reported to the SEC under GAAP. (Note that Zynga’s non-GAAP-earnings number also excludes depreciation, amortization and Zynga’s considerable stock-based compensation expenses.)
Such flexibility underscores why an independent auditor is critical for shareholders. The Big Four public accounting firms all provide services to growth companies that might one day go public.
Besides being profitable, it gives them an inside track to an auditing appointment, which can produce hundreds of millions in revenue over decades. (During the Sarbanes-Oxley debate the accountants beat down attempts to force a company to switch its auditing firm every five years.)
But E&Y is the most brazen in how it communicates this relationship. PricewaterhouseCoopers’ “Roadmap for an IPO” guide, for example, stresses the importance of auditor independence, mentioning it five times. By contrast, Ernst & Young’s latest “Guide to Going Public” emphasizes its role as a business advisor and client advocate, while never once mentioning auditor independence. The clear message: Advocate first, auditor second.
It doesn’t hurt that many of the people E&Y is pitching for business once sat on the E&Y side of the table. The firm’s CPAs are often lured by options-wielding clients to work in-house. The chief accounting officers at Facebook and Zynga are both E&Y alums. (Villanova University accounting professor Anthony H. Catanach cites such “incestuous” relationships as a key reason E&Y audit client Lehman Bros. saw its balance sheet collapse. The technique Lehman used to hide debt and a growing liquidity crisis was created by a Lehman CFO who was a former E&Y partner leading E&Y partners to assume it was legit.) Sarbanes-Oxley now bars an auditor from moving to a company he’s directly auditing but not to other companies that are audited by his firm.
Confused yet? Zynga’s investors surely are. And as long as firms like E&Y have wide latitude to judge the accounting rules at companies where they legally may have created such creative structures, rest assured that such confusion will grow as rapidly as FarmVille’s virtual kudzu.
SouthAmerica: Watch this video from 12 min point to at least 20 min - a point on this video where Max Keiser mentioned how fraudulent and corrupt the US stock market has become – and he also mentioned the Zynga, Fecebook and Groupon connection with Ernst & Young, and how investors lost over US$ 62 billion dollars on the IPO of these companies in a very short time period.
Alex Jones w/guest Max Keiser: The Raping of A Country! - August 17, 2012
On the Friday, August 17 edition of the Alex Jones Show, Alex welcomes economist, journalist and American broadcaster Max Keiser to discuss the warning signs of an impending economic collapse, the effect this will have globally and solutions that would bring us back from certain financial doom.
SouthAmerica: According to journalist Naomi Wolf the crackdown that has been happening in the United States against journalists is related to an effort of the US government to intimidate and to stop the journalists from reporting the massive amount of rampant fraud that we have in US financial markets, and prevent the incarceration of all these crooks who are in control and run Wall Street today.
'US classifies info & punishes those who tell the truth' – August 18, 2012
Julian Assange's case has raised numerous concerns among journalists and activists who fear being prosecuted for doing their job. RT interviews author and journalist Naomi Wolf, who says the US government is especially tough on those exposing official wrongdoing.