Financial reporting has been under a magnifying glass since the scandals at Enron Corp., WorldCom Corp. and other companies rocked the nation earlier
this decade.
The corporate fraud found at those companies forever changed the accounting industry as it brought the demise of Big Five firm Arthur Andersen LLP and pushed the government to rigorously monitor accounting at publicly traded companies with the 2002 Sarbanes-Oxley Act.
Then came stock options backdating and last year’s subprime mortgage meltdown and subsequent credit crunch. They brought even more scrutiny by regulators and now federal prosecutors.
Orange County companies were at the center of the mortgage and options backdating scandals. They included chipmaker Broadcom Corp. and mortgage lender New Century Financial Corp., both of Irvine.
Broadcom got hit with the largest restatement bill of any of the 150 companies investigated for stock options backdating. In early 2007, Broadcom took charges of $2.2 billion to past earnings to fix misdated options.
The scandal prompted intense probes from the Securities and Exchange Commission and federal prosecutors.
Broadcom cofounder Henry Nicholas and former finance chief Bill Ruehle were charged with a total of 21 counts of plotting to backdate options for employees brought on board at the company during Nicholas’ time as chief executive, mostly from 1998 to 2003.
Both pleaded not guilty to the options charges and are set to stand trial next April.
Cofounder and former technology chief and chairman Henry Samueli pleaded guilty early last month to one count of lying to federal investigators about his role in options backdating. He struck a deal in which he would pay $12.2 million and serve three to five years of probation.
The company’s auditor, Ernst & Young LLP in Irvine, wasn’t charged with any wrongdoing.
Mortgage Meltdown
New Century also made headlines after its implosion last year.
The company, one of the nation’s largest subprime mortgage lenders, spiraled in early 2007 when executives warned of a quarterly loss, projected a big drop in 2007 loans and said some results would need to be restated to fix accounting errors.
The subprime lender filed for bankruptcy in April 2007.
New Century, the poster child for the mortgage boom and subsequent meltdown, is winding down in bankruptcy court. Its former executives are under investigation by the U.S. Attorney’s Office in Santa Ana.
In a bankruptcy court report on accounting issues at the company that was unsealed in March, court-appointed examiner Michael Missal blamed New Century’s senior management and auditor New York-based KPMG LLC for creating a “ticking time bomb” of risky loans and improper accounting.
His report stops short of alleging fraud by New Century and KPMG.
KMPG has since denied the report.
While Broadcom, New Century and other companies tangled in options backdating and the mortgage crisis have fallen under great scrutiny, their accountants have remain unscathed.
In Broadcom’s case, it could be argued executives went out of their way to keep Ernst & Young from knowing about options backdating.
So far accounting firms haven’t taken too much heat for the sins of stock options backdating. Some industry watchers think it’s too early to tell what the fallout will be from the mortgage meltdown, which might bring specific auditors into the fire.
The scandals of years past were a wake up call for the accounting industry.
The SEC’s strict accounting rules greatly increased the quality of accounting work over the years, accounting firms, universities and associations say.
“After WorldCom and Enron and all of the other scandals, auditing became a much more regulated industry,” said Morton Pincus, accounting professor at the University of California, Irvine’s Paul Merage School of Business.
One Sarbanes-Oxley rule, Section 404, has kept local accounting firms busy, as it requires public companies to examine and test their internal controls and hire external auditors to check their processes. But the onus still lies with the management team.
“At the end of the day financial reports are always management’s responsibility because they’re the ones who sign them off,” said Vivek Mande, accounting professor at California State University, Fullerton.
Accountants’ Responsibility
Still, some may wonder if accounting firms could bear any responsibility in some of the headline grabbing scandals seen in OC, Mande said.
“Some people may wonder why accountants didn’t catch some of the stock options backdating before it happened or why they couldn’t come up with the right valuation for subprime loans before they were sold to Wall Street,” he said.
Local accounting firms couldn’t talk specifically about how they’re dealing with stock options backdating scandals and subprime mortgage clients due to confidentiality agreements and the sensitivity of these issues.
Some offered to weigh in on the increased pressure they face.
“Ever since Enron, the microscope is still on the accounting industry,” said Robert Lucenti, managing partner of the Costa Mesa office of New York-based Deloitte LLP. “We’re in an industry right now that is under heavy public scrutiny and that challenges us to stay at our best.”
“Whenever there’s an issue where companies are reporting and filing, the marketplace turns to us and says ‘What did you think about it?'” Lucenti continued. “That’s just part of doing business as an accounting firm.”
John Belli, managing partner of Ernst & Young in Irvine, said the mortgage crisis and stock options backdating are challenges that affect everyone in the accounting pipeline from management and regulators to accounting firms.
“We have to constantly look at our processes and we need to make sure they are appropriate so we can do the best job,” Belli said.
Firms have to protect themselves from blame by stressing quality, integrity and ethics, Lucenti said.
“Companies and investors want to know that we can get the right answer,” Lucenti said. “It just comes down to doing the right thing.”
