SEC to require disclosures on global warming risks

Yes, that's right, the SEC has announced that it wants public companies to try to estimate the risk that global warming poses for their assets or operations! No, I didn't get this off The Onion News Network either! Just do a Google Search and you will see articles in The NY Times and elsewhere.

So what does this mean? I suppose, for example, if the company believes it is too close to the rising oceans and could be under water sometime in the next millennium then it needs to disclose that risk! Also, if a company believes legislation on global warming could negatively impact future earnings then the company needs to disclose that risk.

I personally think that the effects of global warming are so hard to predict that companies could comply with this requirement in one sentence: "The effects of global warming or legislation related to global warming on the Company's assets or operations are not estimable in any reliable way." Seems like some wasted ink to me. Maybe the SEC wants companies to say something like: "The impact on the environment from the extra paper necessary to disclose the possible effects of global warming will not lead to any serious litigation since the company is required by the SEC to go through this silly exercise!"

We can only assume that the SEC will be spending time and money reviewing these disclosures to determine if companies are sufficiently complying. Never mind that they had their hands full and failed to regulate some huge Ponzi schemes such as those operated by Bernie Madoff and R. Allen Stanford before investors lost tens of billions in these schemes! Is this really a priority?!

It seems that investors have serious risks of fraud in this world. Scammers such as Madoff, Pang, Stanford, and companies such as Enron, Worldcom and Satyam need to be regulated and shut down. The SEC needs adequate resources to do these jobs and it has appeared to lack the necessary funding for decades. However, if this is their focus in the future then I question whether voters will sympathize with their calls for additional funding!

Satyam Fraud

A report by the Comptroller and Auditor General of India indicates that the Satyam fraud could have been uncovered in 2007 (source). However, a government agency appears to have looked the other way, allowing the fraud to continue undiscovered until January 2009. Many of the fraudsters who have been exposed over the past year or so seem to have had an uncanny ability to get government agencies to look the other way.

More on Satyam's Auditors

Following up on Satyam's auditors, the Times of India reports that Satyam was not audited by PwC (emphasis added):

The questioning of Ramesh Rajan, chairman and CEO of PricewaterhouseCoopers, India (PwC) by CBI last week, has revealed that the Satyam balance sheets were in fact audited by Lovelock & Lewes and not Price Waterhouse (PW). It is also learnt that the auditing fees, though deposited in the name of Price Waterhouse, Bangalore, was later transferred into the account of Lovelock & Lewes. "It is from here that the partners S Gopalakrishnan and Srinivas Talluri withdrew the money," sources involved in the investigation of the case told TOI.

Apart from Rajan, other senior partners of PW, from Delhi and Kolkata, were also summoned by the CBI last week. The partners denied any association with PW, Bangalore and said that Gopalakrishnan and Talluri were not entitled to sign any balance sheet on behalf of PW. "So as it turns out, the auditors who are partners with PW, Bangalore, wrongly signed under the name of PW, and also outsourced the work to Lovelock & Lewes," said sources adding that investigations confirm that the entire auditing team at Satyam is from Lovelock & Lewes.

I am left wondering how all of this could happen without the knowledge of PwC India...

Making examples of Satyam's auditors

It looks like India's judicial system is a bit different than what we're used to here in the U.S. Two PricewaterhouseCoopers partners who worked on the Satyam audit have been in prison for four months while awaiting trial. The partners claim they had no idea of the fraud and that it was carefully concealed with fictitious documents. Apparently, the prison conditions are not exactly country club conditions either.

A New York Times article explains the partners' situation as follows:

The prison, opened in the 1800s, is surrounded by high watchtowers and a concrete wall. Behind its hulking, metal-studded front door live more than 900 men, held for crimes like pick-pocketing and murder. Then there are the two accountants....

The auditors, who are technically in “judicial custody,” are luckier than most prisoners here. Their wives can bring them food from outside during their twice-weekly visits. But they receive few other privileges. They sleep on the floor in a cell with other inmates, in temperatures that often exceed 100 degrees...

Accounting experts say that while authorities may be treating the PricewaterhouseCoopers partners particularly harshly, making an example of them may prevent more serious repercussions for the country’s economy and even the audit firm itself.

I wonder what they do when they catch terrorists in India...

Detecting Fraud: Lessons from Satyam

BusinessWeek has an interesting article on the Satyam fraud. One of the most amazing thing about this fraud is that the fraud appears to have been primarily a cash fraud (i.e. the company claimed to have cash that didn't really exist). The authors of the article discuss two possible scenarios that could have resulted in the fictitious cash balance: (1) fake sales and (2) theft of real cash. Because of the inherent difficulty in creating fictitious sales and sustaining such a fraud over an extended period of time (the problems at Satyam allegedly took place over seven years), the latter possibility appears to be the most likely. In the words of the article:

Consider, again, the $825 million Satyam reported as investments in bank deposits in its consolidated balance sheet as of Mar. 31, 2008. If one were to substitute the line item "investments in bank deposits" with "Chairman Raju's personal account," this scenario assumes significance. As such, the hypothesis we raise is that Satyam was a legitimate cash-generating business over time; that Raju misappropriated Satyam's cash; and, that most of the misappropriation was probably not reflected on the company's books.

If this is true, it implies a major failure in corporate governance, including a significant audit failure by Satyam's external auditors. Ironicly, cash is generally considered one of the easiest accounts to audit and junior auditors often complain when assigned to audit of a company's cash balance because the task is perceived to be very basic.

While the authors conclude that, "Only a detailed analysis of the cash flow statements could have caught [the fraud]," I am not completely convinced. While closer scrutiny of the cash flow statements may have helped raise some red flags, I am not sure that it would have been sufficient to uncover this fraud. Instead, I believe that Satyam's auditors would have been more likely to catch the fraud by engaging in additional strategic reasoning.

In other words, Satyam's management was most likely able to fool the auditors by considering the auditor's standard procedures for auditing cash and developing some method of fooling those audit procedures. If the auditors had considered how Satyam's behavior might change in response to their basic procedures, the auditors may have been able to develop better procedures that may have caught the fictitious balance.