Dear Mr. Sloan (Newsweek):

I don't know if you read the LA Times Business Section, but last Sunday
they had three great great articles to which I was compelled to
respond.  What follows is my dissertation on the whole Enron/Andersen
mess and their articles.  As I know this subject is of interest to you,
I thought you might just want to read my take on the subject.  I have
delayed in sending it to you until I started getting some feed back from
some of the 50 people I sent it to, and so far it has all been positive,
so I thought I would send it on to you.

Harold L. Katz
hkatz@katzfram.com

"Harold L. Katz" wrote:

James Flanigan, Editor Business Section, Los Angeles Times:

I was blown away by Sunday's Business section and the various articles that dealt with the problem of accounting for today's business world.  On balance it was a great piece of work and a great service to your readers.

What follows is an exercise in frustration as you can't print it as a letter, and you may well ignore it in total.  However, it is something I had to write and I hope you will read.  Our capitalistic system faces a great danger, and I am not convinced that your writers really appreciate the seriousness of the problem.

There is a world of 150,000 or more CPAs in public practice who are not associated with the Big 5, and who have a stake in the outcome of the mess the profession now finds itself in.  Some of them, including me, have a very different take on what happened, and why, than the AICPA and the Big 5.  Our frustration is that we cannot make ourselves heard.

The first simple truth is a question.  If investors and lenders can no longer trust the content of a financial statement, how is our capitalistic system of free enterprise and markets to function?  This is not a rhetorical question.  I know that defenders of the status quo point out that there have only been 437 financial statements restated during the last couple of years, but those restatements have cost lenders and investors billions of dollars.  I cannot accept the number 437, even if there are tens of thousands of financial statements that have not been restated (yet?).

In a few years the two most difficult words in an elementary school spelling bee will be ?ethics? and ?integrity? as both words will have disappeared from common usage, as they have disappeared from the world of business.

The second simple truth is a statement.  The economic rules I learned in High School in 1950 still apply today and they will apply until the law of gravity is reversed, contrary to those who stated the following, as quoted from page C6:

         ?The accounting principles, even with all the new rules, fail to           address the development of what many call the information or intellectual economy.  Determining the value of intellectual assets, such as a proposed venture to deliver an Internet product, is very different from calculating the profit on a shipment of doorknobs.  The nation's system of financial reporting has become so complicated that many in the industry are asking whether it should be scrapped for new one.?

This entire concept belongs in a barn, along with the cows that produced it.  If you cannot reasonably value an asset, it has no value .  Furthermore, guesses at what the future holds have no measurable value.  Guessing the future belongs in the President's letter, not in the financial statements.  Then the investor can make a decision as to when, and if, to buy the stock, based on the reporting of real earnings and real growth patterns.  It is the investors? right to decide if they want to gamble.  It is not the companies right to assign misleading and untrue values to an intangible asset so as to entice the investor into putting his money on the line based on smoke and mirrors.

Contrary to the example given, I find no difference between the rules I had to apply to determine the value of a shipment of doorknobs than I do intangible assets, which I liken to ?cotton candy.?

This leads me to my description of the ?new cotton candy theory of economics.?   It looks good, it tastes good, there is nothing there but air, and if you eat too much of it, you get sick to your stomach.  This new cotton candy theory of economics has been brought to us by the best of the graduates of our finest advanced schools of Business Administration.  A perfect example is Nancy Wallace, who teaches at the School of Business Administration at U.C.  Berkeley, whom you quoted.  I ask you, what is the difference between her teaching her students how to falsely keep earning elevated and balance-sheet assets low, and teaching a class on to rob gas stations and 7-11s, and get away with it?  To me the difference is getting a couple of hundred dollars in the robbery, versus cheating the public, institutional investors, and lenders out of billions of dollar.  In the first case the criminal might go to jail for 25 to life for stealing a couple of hundred dollars, and the graduate of Professor Wallace?s class gets a golden parachute.

In 1995 the FASB and SEC wanted to force companies to report exercised stock options as an expense.  Big business, the Big 5, the AICPA and the lobbyists descended on Congress to fight this concept.  They said to do so would depress earnings and drop the value of stocks.  Had this been an earlier era it might even have been called a Communist plot to destroy the market place.  Yes it would have reduced reported earnings; it would have reduced them to actual.  Yes, stock prices would have been depressed; they would have dropped to a level that more accurately reflect their true worth.  Many elected officials in Washington that rail against big government's interference in the free enterprise system, embraced this interference and the Congress, including Senator Joseph Lieberman, stopped this plan dead in its tracks.

A number of articles published recently listed major companies whose ?reported? earning would be decreased by 30-40% if they had booked their stock options as an expense.  They are overstating their earnings as stock options exercised are salaries and should be charged as an expense.  While the method used may be legal, it is ethical fraud, and it continues to this day.

When companies like Global Crossing and Enron, as reported in the LA Times, sell the right to assets, some real, and some imaginary (Enron's Braveheart Project), over a period of years, to one of their Special Purpose Entities (SPEs) in which they own 97% of the equity, and book the entire sales proceeds as net income, it may be legal, but it is still a fraud upon the public.  I would like to believe that if I were the partner in charge of the Enron or Global Crossing audit, and was forced to approve these kinds of transactions, or lose my job, I would have had the courage to find another place to make a living.

Let me next deal with scrapping the complex rules of accounting and starting over.  This will only work if the original rule I was taught in college and in practice, by my mentors, is the cornerstone of the new rules.  That is that rendering an opinion on the financial statements for a client is somewhat of a dichotomy.  The client pays the fee, but the responsibility is to the reader of the financial statements.  What has happened is that the Big 5 has found itself torn between their concern for the consulting fees generated and their responsibility to the readers of the financial statements, and the fees have won.

I, for one, have not reached the conclusion that Congress seems to have arrived at, that a CPA firm cannot do both an audit and consulting work.  As far as I am concerned, the jury is still out on that one.  In my opinion if a CPA remembers his/her responsibility to the reader of the financial statement, is honest of heart, and embraces ethics and integrity in conducting his/her professional responsibilities, I think they can do both consulting and auditing.  Unfortunately, there is a serious question regarding the current leaders of the Big 5, and some other firms, and their ability to live by a higher rule than the bottom line.  The funny thing is if all CPA firms lived by the old rules, there would be no advantages to any of the CPA firms and their clients would have to tow the line.  Then everyone would be better off.

At the beginning of your article, on page one, you quote from an annual report to the SEC.  I read that footnote four or five times and I had no idea what they were saying.  This may be legal but it is ethical fraud to the investors and lenders.  If I, with 40+ years of experience, do not understand what they said, how can a lay person.

Several years ago I was invited to a morning meeting at which several experts in the field of ?derivatives? spoke.  A major brokerage house had flown them out from their NY office.  At the conclusion of the presentation I turned to my host and said, I am a very smart man and I didn't understand one word of what they said, and in my opinion, the presenters didn't understand what they were saying or what it all meant.  Trading in derivatives has cost a lot of otherwise intelligent investors a lot of money.  I again quote from your article:

        " Much of this (derivatives) is so complex that people who have been trained in a much simpler economic model just don't understand it well?That includes auditors, board members, and even the regulators.  This is not simple arithmetic."

If the above statement is true, and I believe it is, then derivatives shouldn't be legal.  A secondary problem is that, in my opinion, those who claim to understand derivatives do not really understand them.  So, large numbers of people are dealing in a market that few, if any, really understand.

Let me close with this comment.  In Washington D.C. the elephants urinate on the donkeys and the donkeys urinate on the elephants, while both animals defecate on the public.  How can a Congress ever correct the problems that the business world and the accounting profession face when all three groups suffer from a lack of ethics and integrity and when you boil all the hyperbole away, that is the real problem, a lack of ethics and integrity, profits over protecting the rights of lenders and investors . Having said that, there are many ethical CPAs who operate with integrity, and it is important that this be remembered.

Finally I bet Ken Lay wears an American flag on his lapel.  I'm sure he supports the President's war on terrorists.  I bet all those partners at Andersen who dreamt up all those offshore entities also are true patriots.  However, Mr. Lay wants this war fought with other peoples tax dollars, and it appears the Andersen tax planners devised the systems to make sure that Enron not only didn't pay any income taxes on their reported earnings, they managed to get back several hundred million dollars in refunds from taxes paid in prior years.  Its all legal and its all an ethical fraud.

At this length I haven't even scratched the surface of the stories you covered in your extensive, and generally excellent articles on the question of where the capital markets are headed.
 

Harold L. Katz, CPA
11620 Wilshire Blvd., #580
Los Angeles, CA 90025
310 479-7889
hkatz@katzfram.com
 

Subject: A Fairy Tale About Accountants
Date: Sat, 02 Mar 2002 12:58:18 -0800
From: "Harold L. Katz" <hkatz@katzfram.com>
Reply-To: hkatz@katzfram.com
Organization: Katz, Fram & Co.
BCC: Harold Katz <hkatz@katzfram.com>,

A fairy tale to read to your children and grandchildren:

Once upon a time in Fairyland, there was a mighty accounting firm.  It
was known as the Big A.  There were four other mighty accounting firms,
they were known as Big B, Big C, Big D and Big E, but this fairy tale is
only about Big A

Now Big A?s Big Honchos (BHs) all were head quartered in a city in
fairyland known as the Wind Blows Strong.  From Wind Blows Strong the
BHs ran a mighty firm that stretched all around the World.  Now there
were mighty firms in Fairyland that needed Big A?s creative thinking to
make these mighty firms look better than they were.  That way these
mighty firms could entice Fairyland's people with pots of gold to give
them their gold so they could make these pots of gold multiply.

And so, the BHs at the Big A had their little BHs wave their magic wands
over these mighty firms and, behold, the people of Fairyland were
entranced with the golden glow which emanated from the financial
statements of these mighty firms, and they brought their pots of gold by
the truck load to these mighty firms.

Meanwhile, back at the mighty firms, the head elves were busy taking the
pots of gold, arriving by the truckload and moving them from the mighty
firms to the homes of the head elves and some of the not so head elves.

It was a dark time in Fairyland in 2001 when someone noticed that all
those creative ideas from the creative thinkers at Big A had turned out
to be as real as cotton candy.  As the people of Fairyland began to eat
the cotton candy they found that soon there was nothing left of the
cotton candy, and they had a mighty stomachache and all their pots of
gold were gone.

Now, Fairyland had many laws to prevent the people of Fairyland from
losing their pots of gold.  It turned out that these laws were made of
lace, not so fine lace either, as they had many large holes.

Soon large noises were heard throughout Fairyland, as BHs in the
government ran hither and dither saying, oh my goodness, how did these
deeds occur, who can we blame so no one blames us.  Oh my goodness! oh my goodness!

To keep this fairy tale short, for by now your kids or grandchildren are
asleep from this boring fairy tale, but you want to know how it all will
end.

Well, all the accountants in Fairyland were very upset with what had
happened.  Some said, I told you so and others said, how could it have
happened and still others said, mainly the BHs that lead the Association
of Accountants, wait a minute, do not say nasty things about Big A.
This is Fairyland and everyone is considered innocent until proven
guilty in Fairyland and Big A has not had its day in court.

Now, there was in Fairyland a great many little accountants and they
said how could we wait for that day when no Big accounting firm had ever
admitted any guilt in any case and probably wouldn?t in these new cases.

Now, it came to pass on Friday the first of March, 2002 where Big A?s
office in the land of the hot sun and dry climate said to some people
who had lost their pots of gold, here is $217 million, go thee on thy
merry way with 83% of your pot of gold and consider yourself lucky.
Meanwhile, one of the little BHs in the land of the hot sun and dry
climate and one of his little helpers had to give up their right to be a
CPA and the little BH RETIRED from Big A.  This being a fairy tale in
Fairyland, this little BH received a rainbow when he retired and he
followed the rainbow to its end and there were many pots of gold, which
were his, in exchange for his falling on his sword, which in Fairyland,
is made of rubber so as to minimize the pain and not cause any lasting
damage.  Of course, the BHs at Big A said, ?We made a business decision
to settle this matter, WITHOUT ADMITTING OR DENYING ANY WRONGDOING, to enable our firm to move forward??  What else is new?

Now, Big A has two more BIG situations where many people lost their pots
of gold.  One is down in the south of Fairyland, a place where
everything is BIG and the other is out in the West, a land that means
different things to different people.  Down in ?where everything is
big,? Big A is offering $800 million to people who have lost north of
$90 billion.  No one yet knows what will be offered to those in the West
who got involved with a company known as ?Under the Sea.?

One thing you can count on in fairyland, is Big A will never admit
guilt, nor will anyone else.  Much wind will be passed, statements will
be made about how people should go to jail, and no one will go to jail.
Many new laws will be passed that will be made of lace and hurt the
little accountants.  Little people, as well as big people, will continue
to lose their pots of gold.  The system works, just look to the other
fairyland to our North, and to those across the sea to the East.  Their
accounting rules are much weaker than ours, and they are abused by
creative minds, but life goes on.  It seems there is a never-ending
supply of pots of gold.

Isn't Fairyland wonderful?

Harold L. Katz (little accountant)
hkatz@katzfram.com
11620 Wilshire Blvd., #580
Los Angeles, CA 90025
310 479-7889