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Answer the question, including all subpart

Make sure to use the course readings, including the Numbers Game Speech, in your
answers.  The case does focus on earnings management manipulation



washingtonpost.com

Crisis at Refco Raises Questions About Accounting

By Ben White and Terence O’Hara
Washington Post Staff Writers
Saturday, October 15, 2005; D01

NEW YORK, Oct. 14 — Futures-trading firm Refco Inc. teetered on the edge of insolvency Friday, as scandal threatened to take down another major U.S. company, four years after the collapse of Enron Corp.

The rapid fall of Refco, which on Friday began shutting down one of its largest operating units, raised questions that many investors hoped were answered after accounting scandals at Enron, WorldCom Inc. and other big companies.

Among those questions was how such a long list of brand-name advisory firms could scrutinize Refco’s books and not find the alleged fraud, which prosecutors have described as a scheme by former chief executive Phillip R. Bennett to keep as much as $545 million in bad debts off of the company’s books, inflating earnings and bolstering Refco’s stock price.

Bennett was arrested on Tuesday and on Wednesday was charged with stock fraud for allegedly misleading investors who bought shares in Refco’s initial public offering in August. The company said Friday that it was beginning to shut down one of its main operating units, Refco Securities LLC. Refco’s stock price has plunged because of the scandal, wiping out more than $1 billion in shareholder value. The company’s bonds also have plummeted.

The rapid descent into scandal has embarrassed firms that advised Refco and signed off on its books, a group that includes public accounting firm Grant Thornton LLP, private equity firm Thomas H. Lee Partners and Wall Street investment banks Goldman Sachs, Credit Suisse First Boston and Banc of America Securities LLC.

Goldman this week signed on as a financial adviser to Refco and has been trying to help the company find fresh capital. Some observers criticized Refco’s decision to hire Goldman as an adviser after the firm failed to uncover the alleged fraud before the August IPO.

“To me, that was a desperate attempt to slather themselves in respectability that wasn’t terribly well thought through,” said Michael Greenberger, a law professor at the University of Maryland and a former regulator with the Commodity Futures Trading Commission. “Goldman has its own problems here.”

Goldman has been talking with regulators and other financial firms about finding a buyer for Refco or guaranteeing that Refco will not default on any of its trading positions.

In a statement on Friday, Grant Thornton said it was continuing to investigate what happened at Refco. “While our professional consideration is still underway, it appears to be a purposeful deception that required participation by senior management, hidden well enough to also evade numerous other detailed financial inspec

TESTIMONY OF ROBERT ROACH
CHIEF INVESTIGATOR

PERMANENT SUBCOMMITTEE ON INVESTIGATIONS
THE ROLE OF THE FINANCIAL INSTITUTIONS IN ENRON’S COLLAPSE

July 23, 2002

Mr. Chairman, Ranking Member, Members of the Subcommittee, good morning.

Earlier this year Chairman Levin directed the Subcommittee staff to investigate the role of financial institutions
in Enron’s collapse. The Subcommittee staff – both Democratic and Republican – have worked for the past 7 months
on a bipartisan basis to conduct this investigation. We have worked together to review over a million pages of
documents and interview dozens of witnesses from Enron, Andersen, other accounting firms, credit rating agencies, and
a host of financial institutions including Barclays, Citigroup, Credit Suisse First Boston, FleetBoston, JPMorgan Chase,
and Merrill Lynch.

Numerous major financial institutions, both here and abroad, engaged in extensive and complex financial
transactions with Enron. The evidence we reviewed showed that, in some cases, the financial institutions were aware
that Enron was using questionable accounting. Some financial institutions not only knew, they actively aided Enron in
return for fees and favorable consideration in other business dealings. The evidence indicates that Enron would not have
been able to engage in the extent of the accounting deceptions it did, involving billions of dollars, were it not for the
active participation of major financial institutions willing to go along with and even expand upon Enron’s activities. The
evidence also indicates that some of these financial institutions knowingly allowed investors to rely on Enron financial
statements that they knew or should have known were misleading.

Our investigation, among other things, focused on one financing vehicle known as a “prepay.” A prepay is
commonly thought of as an arrangement in which one party pays in advance for a service or product to be delivered at
a later date. Companies use prepays to receive money up front for services to be rendered in the future.

Enron constructed elaborate, multiparty commodity trades that they called prepays in order to book the proceeds
from the prepays as cash flow from operations. But when all the bells and whistles are stripped away, the basic
transaction fails as a prepay and what remains is a loan to Enron using a bank and an obligation on Enron’s part to repay
the principal plus interest. With that being true, the proceeds of the so-called prepay transaction should have been
booked as debt and cash flow from financing, not as a trading liability and cash flow from operations.

In order for transactions like the ones used by Enron and the banks to be legitimately booked as a trading
liability and not debt, four elements had to be present:

– The three parties had to be independent.
– The trades among the three parties could not be li

UNITED STATES OF AMERICA

Before the

SECURITIES AND EXCHANGE COMMISSION

SECURITIES EXCHANGE ACT OF 1934

Release No. 77646 / April 19, 2016

ACCOUNTING AND AUDITING ENFORCEMENT

Release No. 3767 / April 19, 2016

ADMINISTRATIVE PROCEEDING

File No. 3-17214

IN THE MATTER OF

ROBERT D. HESSELGESSER,

CPA,

RESPONDENT.

ORDER INSTITUTING PUBLIC

ADMINISTRATIVE PROCEEDINGS

PURSUANT TO SECTION 4C OF THE

SECURITIES EXCHANGE ACT OF 1934

AND RULE 102(e) OF THE

COMMISSION’S RULES OF PRACTICE,

MAKING FINDINGS, AND IMPOSING

REMEDIAL SANCTIONS

I.

The Securities and Exchange Commission (“Commission”) deems it appropriate that public

administrative proceedings be, and hereby are, instituted against Robert D. Hesselgesser, CPA

(“Respondent” or “Hesselgesser”) pursuant to Sections 4C1 of the Securities Exchange Act of 1934

(“Exchange Act”) and Rule 102(e)(1)(ii) of the Commission’s Rules of Practice.2

II.

1 Section 4C provides, in relevant part, that:

The Commission may censure any person, or deny, temporarily or permanently, to any person the privilege of

appearing or practicing before the Commission in any way, if that person is found . . . (1) not to possess the

requisite qualifications to represent others . . . (2) to be lacking in character or integrity, or to have engaged in

unethical or improper professional conduct; or (3) to have willfully violated, or willfully aided and abetted the

violation of, any provision of the securities laws or the rules and regulations thereunder.
2 Rule 102(e)(1)(ii) provides, in pertinent part, that:

The Commission may . . . deny, temporarily or permanently, the privilege of appearing or practicing before

it . . . to any person who is found . . . to have engaged in unethical or improper professional conduct.

2

In anticipation of the institution of these proceedings, Respondent has submitted an

Offer of Settlement (“Offer”) which the Commission has determined to accept. Solely for the

purpose of these proceedings and any other proceedings brought by or on behalf of the

Commission, or to which the Commission is a party, and without admitting or denying the findings

herein, except as to the Commission’s jurisdiction over him and the subject matter of these

proceedings, which are admitted, Respondent consents to the entry of this O

Financial Oversight of Enron:
The SEC and Private-Sector Watchdogs

Report of the Staff

to the

Senate Committee on Governmental Affairs

October 8, 2002

Financial Oversight of Enron:
The SEC and Private-Sector Watchdogs

INTRODUCTION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1

PART ONE: THE SEC AND OTHER WATCHDOGS WITH LEGAL
OBLIGATIONS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7

I. BACKGROUND . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8
A. The SEC . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8

1. Mission and Organization . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8
2. Review of Public Filings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9
3. Enforcement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13

B. Private-Sector Gatekeepers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16
1. Boards of Directors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16
2. Auditors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20

II. EXPERIENCE WITH ENRON . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24
A. Private-Sector Gatekeepers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26

1. Enron’s Auditor . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27
2. Enron’s Board of Directors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28

B. The SEC . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29
1. Review of Enron’s Public Filings . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31
2. Enron’s Shift to Mark-to-Market Accounting . . . . . . . . . . . . . . . . . . 40
3. Exemptions from the Public Utility Holding Company Act . . . . . . . . 47
4. Exemption from the Investment Company Act of 1940 . . . . . . . . . . . 57

III. RECOMMENDATIONS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 61

PART TWO: MORE WATCHDOGS – WALL STREET SECURITIES
ANALYSTS AND CREDIT RATING AGENCIES . . . . . . . . . . . . . . . . . . . . 69

I. ENRON AND THE WALL STREET ANALYSTS . . . . . . . . . . . . . . . . . . . . . . 69
A. Investment Research Analysts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 71
B. The Wall Street Analysts’ Assessments of Enron . . . . . . . . . . . . . . . . . . 72
C. Factors Affecting the Objectivity of Se

UNITED STATES BANKRUPTCY COURT
SOUTHERN DISTRICT OF NEW YORK

In re:

REFCO INC., et al.,

Debtors.

§
§
§
§
§
§

Chapter 11

Case No. 05-60006 (RDD)

Jointly Administered

Final Report of Examiner

JOSHUA R. HOCHBERG (JRH 9440)
MCKENNA LONG & ALDRIDGE LLP
1900 K Street, NW
Washington, DC 20006-1108
Telephone: (202) 496-7500
Facsimile: (202) 496-7756

Court Appointed Examiner

CHARLES E. CAMPBELL (CEC 6100)
ROBERT A. BARTLETT (RAB 0550)
MCKENNA LONG & ALDRIDGE LLP
Suite 5300, 303 Peachtree Street, NE
Atlanta, GA 30308
Telephone: (404) 527-4000
Facsimile: (404) 527-4198

Counsel to the Examiner

TABLE OF CONTENTS

Page

-i-

I. INTRODUCTION …………………………………………………………………………………………… 1
A. OVERVIEW OF THE FINAL REPORT …………………………………………………………….. 1

B. SUMMARY OF THE MATTER UNDER INVESTIGATION ……………………………………… 3
C. SCOPE OF THE EXAMINATION……………………………………………………………………. 5

D. SUMMARY OF CONCLUSIONS ……………………………………………………………………. 7
II. PROCESS OF THE EXAMINATION ………………………………………………………………… 8

A. ESTABLISHING THE SCOPE OF THE EXAMINATION …………………………………………. 8
B. FACTORS THAT INFLUENCED THE EXAMINATION ………………………………………….. 9

1. Factors that Aided the Examination………………………………………………… 9
2. Limitations on the Examination …………………………………………………… 11

C. PROCEDURAL ASPECTS OF THE EXAMINATION …………………………………………… 13
1. Staffing the Examination…………………………………………………………….. 13

2. Coordinating the Examination……………………………………………………… 14
3. Monitoring and Participating in the Bankruptcy Cases …………………….. 14

4. Obtaining and Reviewing the Documents………………………………………. 15
5. Witness Interviews…………………………………………………………………….. 16

III. HISTORY OF REFCO AND ITS AFFILIATES…………………………………………………. 16
A. BRIEF HISTORY OF THE REFCO DEBTORS ………………………………………………….. 16

B. ROUND TRIP LOANS AND SIMILAR TRANSACTIONS……………………………………… 22
1. Overview …………………………………………………………………………………. 22

2. Impact of Loans on RGHI Receivable……………………………….

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