So why are clearly stated intentions so often lacking? How else can one be assured others are working with them to achieve the same goal(s)?
Here are the most common reasons to keep intentions hidden:
- Fear others won’t share the intention, and may force a change to the status quo if the intentions are disclosed;
- Fear of ridicule or criticism—especially the more public the intention would be exposed;
- Trying to keep options open—if the intent doesn’t come to fruition, but wasn’t stated, then no one will know the desired goals weren’t achieved;
- And, quite often, hidden intentions are kept undercover because they’re downright wicked.
Speaking of wicked intentions, one of my inspirations for today’s post is Narcisse Dansu, author of the blog, StudentCPA. He’s been debating the topic of corporate earnings management practices with me. The discussion started in response to my post entitled, “There’s Something About You, Jamie Dimon” which pointed out that JP Morgan Chase’s much-heralded Q1 2010 performance improvement of $1.2 billion over prior year was primarily attributable to the $1.1 billion reversal/reduction of credit card bad debt reserves—essentially an earnings management maneuver.
Narcisse firmly believes all earnings management practices are “inherently deceptive.” I debated this with him, pointing out that JPM’s $1.1 billion earnings management massage of their credit card bad debt reserves had been fully disclosed (otherwise I wouldn’t have been able to point out that it had occurred). Given JPM’s earnings management maneuver was disclosed, why did he still consider it to be deceptive?
Trying to argue along rational intellectual lines, Narcisse offered several examples of why earnings management practices were harmful (click here to read the comment stream). Enjoying the debate, I stripped most of his examples away by pointing out the “grey areas,” where the very practices he was bemoaning could be beneficial and not evil. After several days of debate, I believed I was wearing him down.
Ah, but young Narcisse is wise beyond his years. Finally instead of coming up with more examples for me to knock down, he started asking questions. Below is his question that stopped me dead in my debating tracks.
“. . . I stated that ‘earnings management practices are inherently deceptive.’ I still stand by that statement even though I reckon that it might come back to haunt me some day . . . When it comes to earnings management as it relates to publicly traded companies, it can be very difficult to differentiate a corporate board trying to exercise its fiduciary responsibilities to shareholders from one that is ensuring that its equity and/or earnings performance based compensation keeps appreciating. Can you tell one from the other?”
As a former fraud auditor, corporate earnings massager, and all-around financial statement manipulator, I was usually pretty adept at determining when the accounting fun and games were within the rules (GAAP or other regulatory requirements) and whether or not the accounting practices or financial products we were using met the “spirit of the law.” I was ready to answer Narcisse’s “Can you tell one from the other?” with a definitive “yes,” but couldn’t answer the inevitable “how” question as swiftly.
It’s like determining the intent of a gentle caress. Is it nothing more than a warm “I hope all is well with you?” Maybe it’s the prelude to intended further touching. Or at the other end of the spectrum, perhaps there were no hidden intentions and the caress was simply accidental.
In the end, whether you’re talking about earnings management practices, use of bundled mortgage securities and other complex financial products, or even the wickedness or not of a gentle caress, it all comes down to intentions.
Narcisse, like the SEC and the financial regulatory reform bill up for initial vote this week, would like to see boundaries (basically just guidelines given the way our existing financial regulatory system is established) around the use of various financial products and financial statement manipulation processes. While such boundaries can help well-intended corporate citizens figure out acceptable behavior, guideline-type boundaries are rarely a concern of those pursuing undisclosed, wicked intentions.
The problem with thinking this way about financial regulation is that it’s not the processes or products themselves that are inherently deceptive, just as a gentle caress itself is what it is—nothing to be alarmed about on its own. It’s not the products or processes, it’s people that create and perpetuate frauds. Sure, certain processes or products may lend themselves to easier manipulation than others, but human beings can pretty much figure out how to manipulate anything. Therefore for every practice or product that is outlawed or tightly regulated, a new, more creative one to achieve the same wicked intentions will be developed.
So, getting back to Narcisse’s question, how can you tell the good from the bad? The okay from the unacceptable? You have to understand the people involved and determine their true intentions.
To catch a fraud you start with a suspected area or person(s). Then you audit everything they say was their intention and process (called “representations” in accounting speak) and compare it to what you can actually observe (“detailed tests” in audit lingo). Any and every discrepancy (where what they said doesn’t agree to what you witnessed) is reviewed in detail (“100% confirmation”) and low and behold you usually discover the fraud and its aftermath in the discrepancy details.
For a fun read about tracking frauds using everything from ski slope adventures to romantic encounters to expose the wicked details, read my novel, Shell Games, available at Amazon.com .
Therefore the most difficult frauds to detect are the ones where the intentions are never declared. It’s harder to search for validation of assumptions with undisclosed intentions because there’s no “true north” to compare observations against. As a financial regulator, like Mary Schapiro’s SEC or Sheila Bair’s FDIC, you’re forced to develop your own hypotheses about intentions and then test your observations against those assumed intentions usually well in advance of being able to talk with anyone at the company directly about your suspicions. Talk about a waste of time.
With respect to determining the intentions of earnings management or other financial statement manipulation products and processes, the best controls I’ve seen center on the auditors being paid and managed by the party with the most to lose. (For example, auditors reporting to corporate headquarters investigating suspected manipulation of financial results to pay out higher cutoff bonuses in a recently acquired business unit. The commissioner of the audit actually desired the fraud to be found, and intended to take action, if the fraud did occur.)
With respect to current events, the following articles from the front page of the Money & Investing section of the 4/24-25/10 Wall Street Journal exemplify just how essential intentions are in the financial world.
“The Fed’s Focus: How to Sell Its Mortgage Securities” by Jon Hilsenrath. “If they sell the assets,” (the Fed holds $2.38 trillion of the mortgage-backed securities market—about 1/5th of the outstanding securities), “it is clearly going to have a pretty big impact on the long end of the bond market . . . many officials want to stay flexible,” (not willing to state their intentions to sell or not in advance), “to avoid locking themselves into a course they might need to change later. (It is) neither necessary nor advisable to decide upon a single game plan . . .”
“SEC’s Top Cop Oversaw Deutsche CDOs” by Aaron Lucchetti and Kara Scannell. “Securities and Exchange Commission enforcement chief Robert Khuzami oversaw a group of lawyers at his old firm, Deutsche Bank AG, that was closely involved in developing collateralized debt obligations, the same product in the agency’s (SEC’s) fraud lawsuit against Goldman Sachs Group, Inc. . . Before taking his current job at the SEC last year, Mr. Khuzami spent five years running the U.S. legal division of Deutsche Bank, one of the largest issuers of collateralized debt obligations in 2006 and 2007.” Is it possible Mr. Khuzami may have had some hidden intentions when he moved over to the SEC and took what I can only guess was a substantial cut in pay?
“Raters Grilled Over Relationship With Bankers” by Fawn Johnson. “. . . Analysts said they were kept in the dark by Wall Street firms about certain key details of bonds being rated. For example, Moody’s analysts weren’t aware that an Abacus financial product (tied to toxic subprime mortgages) from Goldman Sachs Group Inc. was in part created by a hedge fund that also was betting against it . . .”
So in closing, I’ll say perhaps there’s one other reason we don’t broadcast our intentions—even though we know that’s essential to leveraging the universe to help us achieve our goals. Maybe it’s because we believe we need to be “saved” from what we want—protected from our own wicked intentions, so to speak.
Click here to enjoy the band St. Vincent performing their song, "Save Me From What I Want" compliments of You Tube—possibly the internet invention I love most!
". . . Honey, what reveals you
Is what you try and hide away
And you can tell the planets
Or your pillowcase . . .
Save me save me save me from what I want . . . "
Please read my post entitled “A Nice Piece of . . .” for links to an easy way for you to spend a few minutes giving our U.S. Senators a piece of your mind (or mine as the case may be) about how to make sure we are better protected against audit failures in another bailout or government intervention situation. Thanks in advance for joining me in trying to make a difference.
Ciao for Now,
Sara McIntosh
