Jamaica Water Properties

 Introduction
The case is about an accounting fraud that involves the Jamaica Water Properties, Inc. This fraud was discovered by David Sokol, who was at that time served as COO (Chief Operating Officer) of the Jamaica Water Properties, Inc. The main culprit was Ernest Grendi, JWP’s CFO, helped by several of the company’s senior accountants. Moreover, the company’s external auditor, Ernst & Young, seems to be involved as well. This case will show regarding the auditor independence, its duty as professional accountant, fraud, and the perspective from the employees toward their higher-ups management.  Background
Its company’s name, before becoming as JWP, was the Jamaica Water Supply Company. It began its operations in 1886 as a small business that delivered water to a few neighborhoods in the Queens borough of New York City. Gradually, the company expanded its geographic market and eventually became one of New York State’s largest water utilities.
In the mid-1960s, Martin Dwyer took control of the company. Dwyer realized that the heavily regulated water utility industry limited his company’s profit potential, so he decided to expand it into other business. Because of his familiarity with governmental agencies, Dwyer began offering various contracting and construction services to local municipalities. Over the next several years, the company expanded into other lines of businesses by acquiring a varied assortment of small firms in the New York City metropolitan area. During the 1960s and 1970s, the company grew rapidly, while its profits and losses vacillated sharply from year to year. But because of severe nationwide recession and other condition at that time, it drove the company to the verge of bankruptcy. Therefore, to salvage the company, Martin stepped down in 1978 and placed his son, Andrew T. Dwyer, in charge.
It took Dwyer and his associates several years to fend off complete collapse. They restructured the cost structure of the company to increase cash flow, and in the process they lessened some of the debt that was dragging down the company's growth prospects. In Andrew’s lead, from 1980 until the end of 1991, JWP enjoyed 48 quarters of uninterrupted growth. The company grew from 400 employees working out of five offices in 1980 to over 21,000 employees in 195 offices in 1990. Despite of that, Andrew realized that the company’s growth had resulted in a far-flung and unwieldy organization that was difficult to manage and weighted down by disproportionately high administrative expenses. To overcome that, he went in search of an individual who experienced in managing companies facing difficult circumstances. After a while, he found David Sokol and made him as the COO of the company.

 Case
The situation was started to going down after David became a COO. Because of his enjoyment for a challenge, he immediately immersed himself in his new employer’s accounting records. Then, he discovered several suspicious items from the records. His uneasy feeling makes him investigate it further. He was unaware for the fact until he investigated it himself.
It turns out that for over the previous several years, the company’s financial data had been embellished by a pervasive accounting fraud. The abusive accounting practices included misapplying the purchase method of accounting for acquisitions, recording the fictitious assets, etc. all those frauds were caused by Ernst Grendi, JWP’s CFO, helped by several senior accountants who was a CPA and a former employee of JWP’s audit firm, Ernst & Young. Over the course of the JWP fraud, Grendi and his accomplices received sizeable money linked to the company’s overstated earnings. Andrew Dwyer and other top executives were never implicated in the fraud even though they benefited financially from Grendi’s scam.
After discovering those suspicious entries and discussing it with the divisional CFOs, David Sokol met with Andrew Dwyer to discuss the troubling items that he had found. He still wanted to delve into those records further, so he requested that Dwyer authorize to retain an accounting firm other than Ernst & Young to help his investigation. His reason was because he was concerned by the “close relationship” among members of the JWP’s senior accountant and Ernst & Young audit team.
Dwyer agreed to retain Deloitte & Touche to carry out a large-scale investigation of JWP’s accounting records. Sokol continued his investigation while Deloitte & Touche mapped its planned investigation. After obtaining further evidences, Sokol called another meeting with Dwyer. Sokol told Dwyer that he had been misled prior to joining JWP and was considering leaving the company. Dwyer tried to persuade him to remain by offering him “stay bonus”. Sokol was already determined, unfortunately. Shortly after that, he met with JWP’s board and turned over all information he had collected. The following day, David Sokol resigned from the company.

 According the regulation
Section 303 -- Improper Influence on Conduct of Audits

Rules To Prohibit. It shall be unlawful, in contravention of such rules or regulations as the Commission shall prescribe as necessary and appropriate in the public interest or for the protection of investors, for any officer or director of an issuer, or any other person acting under the direction thereof, to take any action to fraudulently influence, coerce, manipulate, or mislead any independent public or certified accountant engaged in the performance of an audit of the financial statements of that issuer for the purpose of rendering such financial statements materially misleading And the concerns on auditor independence, the AICPA’s code also is set firm of professional conduct

 Conclusion
Deloitte & Touche’s investigation continued for several months. When the investigation was completed, JWP restated its previously reported earnings to its correct numbers. Ernst Grendi was forced to resigned as JWP’s CFO. Meanwhile, in April 1993, Andrew Dwyer resigned as the CEO and after that, he also resigned as the company’s chairman. JWP filed for bankruptcy in October 1993.
In 1995 and 1996 the SEC issued a series of accounting and auditing enforcement releases focusing on Ernst Grendi and other JWP accountants involved. Each of them got punishment heavily, especially Grendi.

Questions
1. Place yourself in David Sokol’s position. After discovering the suspicious items in JWP’s accounting records, would you have taken a different course of action than he did? Why or why not?
Answer: if I was in David’s position, I would probably do the same thing David had done. It’s just like he (David) said, “If you ever obtain something by lying, it’s worthless. Integrity is the highest order of the day.” Honesty is one of the important ways to maintain good career. As a COO, I should monitor the daily operation of the company and report the strength and weakness of internal control to the CEO, if any. So, I should be accountable and be responsible for anything that I have done.
2. What measures can and should be taken to make it easier for corporate employees to “blow the whistle” on a fraudulent scheme they uncover within their firm?
Answer: well, there are several measures that can be taken to encourage the employees to “open up”:
a) Protection from being fired or demoted and reinstatement
b) Compensation for loss of wage
c) Compensation for costs of making the complaint and possible ensuing juridical procedures
d) Establishment of Whistle Blowing System
All those measures above can be a consideration depends on the organization.

3. Should businesses, accounting firms, and other organizations explicitly reward ethical behavior by their employees and executives? Defend your answer.
Answer: the truth is this reward system is basically a good thing because it gives them (the employees) the incentive to do the right thing by exposing the fraud. But, we have to be careful because this sort of system can be “misleading” for bad purpose. For example: making false accusation for self-interest. That’s why supervision is needed.

4. List several measures accounting firms can take to reduce the risk that personal relationships between client personnel and members of an audit engagement team will adversely affect the quality of an audit.
Answer: well, if we are talking about the measures to reduce the risks, I think instead of thinking to reduce the risk, we should think of how to make sure that there’s no “personal relationship” between client and audit team. Why? Because it’s already stated that auditor must be independence. If the auditor has a personal relationship with the client, it may clouded the valuation of the audit. The conflict interest may also be involved. That’s why in the beginning, such kind of thing is cautioned, even before audit engagement.
5. Do you believe the 1988 “retention agreement” that Ernst & Young made with JWP was appropriate? Defend your answer.
I think believe because the judge legal opinions in the case contrasted the intense afforts of david sokol to pursue and uncover the fraud despite the intimidating persona of ernst and young willingness to accommodate mr. grendi. And it is can give growth to use Ernst & young have estimate in 1988 to broaden the company's electrical services repertoire. The acquisition of University Industries in 1988 got them into the West Coast mechanical services market. To crack the international market, JWP acquired Drake & Skull Holdings, a British electrical and mechanical services company. Dwyer's JWP gobbled up two dozen companies from 1984 to 1987, generating scale economies out of mergers and getting a jump on the competition in the high tech end of the technical services industry.

6. Why do you believe that Ernst & Young agreed to pay a large settlement to JWP’s stockholders but chose to contest the lawsuit filed against it by the insurance companies?
Answer: Because the E&W has responsibility as an audit partner, covering all future events that happen to their client. In this case, because of Ernest Grendi is an E&W auditor; E&W should take responsibility for his work. The reason for E&W against the insurance companies that have gave fund to JWP is a responsibility for insurance companies if there are some problems happen to their client in the future, they have to prepare for the lose. In this case, the company getting loses, so they have to accept that their fund is also gone with the break of the company