“The Numbers Game”
A Speech by SEC Chairman Arthur Levitt
Article Review

The article, “The Numbers Game” 1 is about the Securities Exchange Commission (SEC) Chairman, Arthur Levitt’s concern over earnings management. Specifically, he expressed during a speech at the NYU Center for Law and Business his distress over an evolving problem with a game played among market participants to manipulate their financial reporting numbers motivated by Wall Street earnings expectations. Chairman Levitt is very passionate and direct in his 1998 speech. It appears that he was invited to honor Bill Allen, the first Director of the NYC Center for Law and Business and he took the opportunity to use this occasion as a platform to voice his concern over the growing problem of market manipulation made by public companies. Mr. Levitt feared that this practice could destroy the quality of earnings and financial reporting. Levitt, the SEC and other aligned corporations were all concerned with the growing practices of financial manipulation fearing that deception appeared to be losing out to integrity. Mark 8:36 says, “What good is it for someone to gain the whole world, yet forfeit their soul?” Corporations who conduct such deceitfulness are winning at the cost of their existence. They are willing to bet their whole life for a few moments of glory on Wall Street. In my opinion, it was very courageous for Mr. Levitt to call out these corporations and put them on notice that their questionable practices were not to be tolerated and for the sake of the American financial system, these accounting practices needed to stop immediately to prevent the eroding foundation originally created for stability and structure of the American financial system. Most importantly, Mr. Levitt also used the NYU forum to rally the financial community and encourage corporations to take a stand by responding to these deceptive practices to cure the disease that had taken hold of the financial markets and was spreading like wildflowers through the nukes and crannies of a revered financial system. Our capital markets are the envy of the world due to our efficiency, liquidity and resiliency. We’ve overcome recessions and have risen even stronger, which is a testament to the strength of our financial markets.
Now, we will take a look at these deceptive financial accounting practices beginning with Big Bath restructuring charges. This occurs when corporations use restructuring as a means to clean-up their balance sheet by overstating these charges to justify their earnings loss in an effort to shift the focus to their future earnings. It has far reaching effects when the corporation reports these numbers conservatively allowing them to use this again when reporting a future earnings at a loss or creeping them back up as income when the earnings estimates change. The consequences are that this accounting practice is a domino effect. There’s too much temptation to lie. Once you lie, you have to keep telling the lie. There is no end, until you really fess up to or get caught in the crime. The upside to this accounting practice, is that when it is used for the purpose of allocating restructuring charges in the appropriate timeframe, it rightly represents the earnings for the best investing decisions. In an article by Bloomberg.com² on corporate earnings, “the earnings number is supposed to represent an accurate snapshot of how well a company's operations performed in a given year. And one of the basic principles of accounting is that both revenues and costs should be matched to the year in which they occur. Otherwise, managers have too much leeway to massage the numbers, and "annual" performance becomes meaningless. But the aim of many of today's giant write-offs is to front-load expenses. They may charge off three years of expenses all at once, and by definition future earnings will be better. It's akin to making three years of mortgage payments at once, then claiming your income has grown.” This was the case for AOL when the SEC opened an investigation in 2002 over the accounting practices of AOL Time Warner. An article by The Guardian.com3 reported “AOL posted its first profit of $394 million for the second quarter compared to a loss of $734 a year earlier. The earlier number had included a 1.7 billion write-down related to goodwill. Revenues were 10% higher at 10.6 billion. The Chief Financial Officer, Wayne Pace cooperated with the investigation and indicated that he defends the books and said they were in line with accepted rules. He added that auditor, Ernest and Young had signed off on all of the accounting measures.” If I were the CFO of AOL, I would have taken a page out of Bill Parson’s book who had been the key figure in the growth of AOL. Bill quit AOL after he was summoned back to the AOL corporate offices to reenergize the company in light of the media surrounding their accounting practices. Mr. Pace should have done the same thing and quit. I’m certain Bill felt there was nothing left for him to do at a company that had sold its soul for Wall Street.
The next questionable accounting practice is the Cookie Jar Reserves. According to the SEC speech1, cookie jar reserves is described as “using unrealistic assumptions to estimate liabilities for such items as sales returns, loan losses or warranty costs. In doing so, they stash accruals in cookie jars during the good times and reach into them when needed in the bad times.” The consequence of using this accounting practice is that what if the bad times don’t come for some time? Where does the accrual get stashed then? The upside of using this accounting principle is when realistic assumptions are used to estimate liabilities, investors get a true picture of the impact to earnings. According to an article published by USA Today4, “the SEC alleged that Microsoft's accounting practices from July 1994 through June 1998 caused its income to be substantially misstated. The agency said Microsoft enhanced its financial results by setting aside artificially large reserves to reduce revenue in good quarters, with the idea of reversing that procedure to record the revenue in less profitable times. The SEC said the reserves totaled between $200 million and $900 million during the period in question. Under a settlement with the Securities and Exchange Commission, the software giant neither admitted to nor denied wrongdoing. No fine was imposed.” In another article published by the New York Times5, Greg Maffei, Microsoft's senior vice president and chief financial officer, said during the investigation, ''We are obviously a company that is known for conservatism, and I would be surprised if someone was to examine our books and suggest otherwise.'' If I were the CFO of Microsoft, I would have responded to the investigation in the same manner with the intent of protecting the integrity of the company, especially since there were no charges brought against Microsoft. The SEC investigation into Microsoft’s accounting practices came after the SEC was also investigating the alleged accounting abuses at a several big companies in the aftermath of Enron's collapse. Also mentioned in the USA today article4, “Xerox agreed to pay a record $10 million civil penalty and revise its financial statements back to 1997 to settle the SEC's allegations of accounting fraud. In addition to investigating Enron's accounting and the role of its auditor Arthur Andersen LLP, the SEC also is examining accounting practices of Global Crossing, the fiber optics company that entered the fourth-largest U.S. corporate bankruptcy in January. The agency also is investigating oil services giant Halliburton for a change in its accounting practices in 1998, while Vice President Dick Cheney was its chief executive.”
In the aftermath of Enron and the SEC investigation into corporate accounting practices, much has changed as prompted by a new legislation signed into law in 2002. In an interview6 conducted by Michelle Norris with the former SEC accountant at the Securities and Exchange Commission, Lynn Turner who said, “Sarbanes-Oxley was legislation passed by Congress in the summer of 2002 and then signed by President Bush. In it, about half of the language deals with setting up a new regulator for the accounting profession called the Public Companies Accounting Oversight Board that oversees the audit firms. The rest of the legislation deals with some important things like ensuring that management is held accountable for the financial reports that they file with the SEC. It improves the independence of corporate boards, as well as the independence of the auditors, and it increased some of the penalties for those who shred documents or violate the security laws.” In response to the interview question asked by Ms. Norris as to what has happened since the law was passed, Mr. Turner went on to say, “We really are starting to see much better audits performed than what we used to see. Errors in the books get caught much quicker, such that the investors aren't given the surprises that they were in the case of Enron and WorldCom and Qwest and the like.”
In conclusion, Romans 3:19 says, “Now we know that whatever the law says, it says to those who are under the law, so that every mouth may be silenced and the whole world held accountable to God.” This article on the speech of Arthur Levitt speaks to the accountability held by the Corporate Chief Financial Officers, Audit Firms, and the SEC to uphold the integrity of the financial markets for the American people, but ultimately unto God on which the financial structure of this country was founded. It is my prayer that Financial Officers manage and report their company’s quarterly and annual financial earnings and Audit firms conduct their audits and SEC provides oversight of corporate financial reporting for the glory of God, the real boss.

Works Cited

1 "Commission Speeches and Public Statements Archive: 1998." SEC Speeches Index, 1998. N.p., n.d. Web. 31 Mar. 2015.
2 “Corporate Earnings: Who Can You Trust?" Bloomberg.com. Bloomberg, 4 Oct. 1998. Web. 29 Mar. 2015.
3 Teather, David. "SEC to Investigate AOL Accounting Practices." N.p., 25 July 2002. Web. 29 Mar. 2015.
4 USATODAY.com - Microsoft Settles Accounting Charges with SEC. Associated Press, 03 June 2002. Web. 29 Mar. 2015.
5 Markoff, John. "Microsoft's Accounting Under Scrutiny." The New York Times. The New York Times, 30 June 1999. Web. 29 Mar. 2015.
6 Norris, Michelle. "Has Accounting World Changed Since Enron?" NPR. NPR, 31 May 2005. Web. 29 Mar. 2015.