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LAW & ORDER - SPECIAL ACCOUNTING UNIT By Mike Gasior I was definitely trying for a clever title for this edition, but please don’t let the mention of accounting cause you to not give me a chance. For this newsletter is more of an interesting story of a journey and not a destination. I will discuss the destination in a different format at a different time. It’s fun that at my now-advancing age to try new things, go new places and meet new people and I’ve had a very exciting and eye opening few months, which I look forward to sharing with you. Plus, I’m sort of thinking that since February is a short month I will give you a break from my more typical economic type of fare. Gosh, when the title of my last newsletter was “The Doomsday Scenario” the only more depressing thing I could do to you is come over to your house and run over your dog. So sit back, relax and let me tell you a story. But quickly, a little bit of business. UPCOMING NEW YORK SESSIONS We will be offering four extremely timely and important seminars in New York in the next eight weeks and I wanted to remind you of them. Here they are along with dates and the link, which will bring you to the complete course description: Advanced Securities & Markets Private Placements & Restricted Securities Mortgage & Asset Backed Securities Derivatives We also still have a variety of convenient dates available if your organization is interested in holding an in-house session for your staff or having me speak at your function. You can view our course catalog, which details all of our "standard" sessions at the link below. Please remember that we are also happy to create a custom program of topics that will be perfectly tailored to exactly your audience's needs at no extra cost. The link for an Adobe PDF copy of the catalog is: http://afs-seminars.com/documents/Catalog2010.pdf Finally, although my schedule for the year is already becoming somewhat tight, I am still open and interested in challenging consulting projects. Please write or call me directly at either mike@afs-seminars.com or (860)347-6568. MY JOURNEY INTO THE LAND OF FORENSIC ACCOUNTING The above heading would normally have sent my eyes rolling as well as perhaps caused me to let out a sigh of boredom earlier in my life. I took all the accounting courses that school required me to take, but I never entertained the notion of becoming an accountant for even a single second. Truthfully, it wasn’t because I had some sort of beef with the accounting profession back in school, but it was simply a matter of not thinking I had the aptitude or disposition for it. It required things that I didn’t seem to have the skill sets for, like precision accuracy for one. I had come from an athletic background where if you’d lacked certain skills, they could be made up for with more enthusiasm or extra work, and that included accuracy. For example, in golf, John Daly lacks MANY of the skills that Fred Couples or Davis Love III have by the bushels, but Big John has twice as many major championships than the other two guys. It seemed to me back in school that at the end of the day, the one thing an accountant needed to be above all other things was ACCURATE. This is where my penchant for economics began since there are very few “absolutes” in economics. Even some of the most lauded breakthroughs are still viewed as “theories”. That sounded appealing to me due to there never seeming to be an absolutely accurate answer. Everything was debatable and nothing was absolute. Over the past 30 years, and more acutely over the past 20, I’ve become (much to my chagrin) an “expert”, if you will, of many accounting topics. It actually will still make me nearly nauseous when I’m invited to be a speaker at an accounting conference, but that’s the road I’ve traveled. And, of all the arcane accounting topics I’ve become one of the world’s leading authorities on, the one that tops the list is statutory accounting for insurance companies (I almost want to stick a gun in my mouth every time I admit that out loud). I tell you all of this because this is where my recent journey begins. I was hired late last year to do a consulting project for a large U.S. insurance company. I don’t accept a lot of consulting work for a combination of reasons. Part of it is a lack of time on my part for longer jobs and the fact that a lot of the work seems as though it will not be very fulfilling for me personally. Mind you, I like making a living as much as the next guy, but I feel I’ve reached an age and level of success where I should no longer accept work just for the paycheck and not be proud of the work that results from my efforts. I would suspect that Eddie Murphy might feel much the same way with regard to some of his movie choices, but I digress. The jobs I tend to accept are usually a blend of true consulting, with an element of education (since I am a born teacher and there is nothing more satisfying in life for me than sharing something with someone that they didn’t know when they woke up that morning) and some good, old fashioned work with my sleeves rolled up. This gig included all of the above and frankly I loved every minute of it. To cut to the chase on this story, part of the work I did during this engagement was some basic review of competitors to the company employing me for the purpose of developing some basic comparison data. And although I have presented my year-end Schedule “D” seminar for the past 21 years, it had been a while since I’d actually had the luxury of sitting down and pouring through the statutory annual statements of some insurance companies. Truthfully, it wasn’t even a “luxury” since I was getting paid to do precisely that. Now before I go too far and begin to lose readers thanks to the previous paragraph, let me do some basic, but minimal, education here, since following the story requires knowledge of some key concepts and definitions: “Statutory Accounting” – The accounting and reporting that insurance companies (in this case) are required to do for insurance regulators in every state that they sell insurance. “Schedule ‘D’” –The assortment of schedules in which the insurance company reports the investments in securities. Schedule D is where they report their stocks and bonds. Schedule DA is where they report their short-term investments. Schedule DB is where they report their derivative holdings. “NAIC” – The National Association of Insurance Commissioners is exactly what it sounds like it is. An association of all the insurance commissioners from the 50 states, that acts to discuss and draft regulations in an effort to make the state laws as uniform as possible from state to state. It basically works, but it still isn’t exactly perfect either. They hate whenever I say it, but they AREN’T a real regulator and truthfully don’t have a damn bit of authority over the insurance industry. Unfortunately, they’ve convinced the industry otherwise. Now you still might be scared that this is going to devolve into a conversation about actually doing accounting, but I promise it most definitely will not. I plan to use my blog and Twitter for the delivery of more detailed reports on those topics, and if you aren’t reading my blog or following me on Twitter, you can link to those here: I admit it to people all the time, even though I'm somewhat embarrassed by this particular talent, but somehow over the past 21 years I have become somewhat like "Rain Man" when it comes to looking at these statutory annual statements. Luckily it's a talent that contributes to my employment. The scariest thing an insurance company can do is hand me their statutory annual statement with a highlighter, red pen and pad of sticky notes then ask me to "grade" it, since very few companies report what I would consider "A" quality work. Before I mire us in a discussion about these statements in particular, what I would like all of you readers to understand is that insurance companies are very unlike many other institutions with regard to the information they are required to make public. Every March 15th these companies file their statements with every state in which they do business in as well as with the NAIC. These are publicly available documents and are VERY easily acquired if you try to find them. What might be surprising, however, is that they detail each investment holding they own and all the data regarding that holding. I mention all of this because it would be unthinkable for some other types of institutions to fathom. For example, a Goldman Sachs or Wells Fargo could never imagine being forced to report such information since it would be looked at as “proprietary” and something that no competitor should ever be allowed to see. This overview I performed as part of this consulting engagement was only meant to uncover and detail some aggregate data about what sorts of investments the competetitors were holding. Such as what percentage of their assets were stocks, bonds, mortgage or asset backed securities. How extensive was their derivative usage? What was the breakdown of the quality of their bonds with regard to investment grade, junk and in default? Basic stuff. There was no real thought in my head about grading these statements, but it’s something that people naturally do as a part of human nature every single day, all day long. Whenever you know how to do something really well, it is difficult to watch someone else struggle while doing the same thing. So in my “review” I saw the usual cavalcade of foolish mistakes, bizarre entries and questionable categorizations. There were empty fields where entries are mandatory. I found mathematical mistakes in many places and hundreds of other bizarre issue, which I’m not going to list for you. I hate to admit this for fear of making my insurance company friends look bad but honestly most of it was fairly typical stuff. Not the kind of items that are Enron material but just errors that happen when dealing with thousands of investments, billions of dollars and not enough hours in the day and you’re the investment accounting department trying to crank this information out on time. Now don’t get me wrong here either. While no company’s statements are perfect, some are better than others and some should just be outright embarrassing to the people who prepared them. I’ve written a little about my findings of mine in my blog and I received a call from a compliance person at one of the world’s largest insurance companies. He wanted to inquire if I had been talking about them with regard to some of the more questionable practices. I left him a voicemail to tell him I wasn’t, but that was the only nice thing I could say. For a company so large (and a company I have worked for many times over the past 20 years) I have NEVER seen such an amateurish display of work in my life and everyone involved should honestly be ashamed. They also had the same problem I found at the companies I focused on, only somewhat smaller. Where this story goes is the reason I’m writing this newsletter. Besides the usual array of foolish oversights, I also stumbled upon what has grown in my eyes into an actual scandal and I’m not the only one who thinks so. I am now working with one of the world’s largest media outlets on this story, and the news will break shortly after March 15th when insurance companies file their final 2009 financials. Over the years and more so recently, I have written over and over about how companies were exaggerating the value and quality of their assets but I’ve always resisted the urge to actually single anyone out as an example. Truthfully, I still feel a little bit funny about it, but I thought it was time to put my mouth where the money is and bring some of these questionable practices out into the light of day. It was for my own comfort that I enlisted a major media outlet as my ally in all of this so I wouldn’t be standing out there alone in any sort of David and Goliath type of battle. If you are going to a gunfight you should never bring only a knife with you, so I wanted a friend this time. Mind you, this wasn’t the way I wanted this to go. When I began to uncover these aggressive and unusual practices I immediately thought that I wanted to alert the companies to what I had found in case the senior people weren’t even aware of it all. The first thing I did was reach out in a very personal way to a few companies I’ve had close relationships with and where I know the actual humans who have the responsibility of preparing the statements. There was some small back-and-forth with a couple of them and then things went silent. I understand that they were already in the throes of year-end preparation and could sort of tell that the news Mike was trying to deliver was not good news. Besides, me helping them would have cost them a few dollars. I know everyone has endured budget cuts and I would have expected to get paid for the work I had already done and would being doing. Their company is paying them to do some horrible work. It would have only cost them a couple extra bucks to look like actual professionals. Still, even after these few contacts, I was thinking that if I were the CFO of any of the companies who I thought were looking for big trouble with some of the presentations in their annual statements. With their own signature gracing the front pages, I figured they would want to know the information I had uncovered. So I crafted a very nice, formal letter for each CFO to introduce myself if I didn’t already know them along with an overview of my findings and the offer to help by preparing a detailed list of everything I found to be wrong. Funnier still is that nearly every single one of these companies has used me for training in some capacity or another over the previous two decades so I thought I might have some credibility with them. The letters went out in the mail and I prepared myself for the deluge of phone calls from concerned executives, worried about regulators, rating agencies, shareholders, policy holders, auditors and anyone else who might be preparing to make their lives suddenly miserable. And what did I hear? Silence. Complete and utter silence. Just over 100 letters went out to these senior people at some of America’s largest insurance companies, and not a one seemed concerned about what I had written to them. Now I was a little ticked off. I had spent more time than I’d really planned on getting my arms around what each company had in their statements prior to sending these letters off, but for no one to care was a literal shock to me. Since I’d already accumulated my own personal collection of insurance company annual statements (you can feel free at this point to write me and tell me that I really, really need a hobby) I thought I’d roll up my sleeves and dig in deeper on a few of the statements that seemed to offer the largest ocean of problems. Even if I was going to be doing all this work pro bono. When I was done, I had totally reviewed, line by line, each and every holding of over a dozen large insurance companies. What I found was actually shocking to me in a way that I had not expected and something that I thought reflected badly on the companies. At that point I knew that I was onto something and that it appeared no one else had managed to notice, even though it was all laid out in black and white and available in publicly available documentation. While not exactly Enron, Bernie Madoff or AIG, we are talking billions and billions of dollars that are questionable and I wasn’t even sure what to do. I’d already reached out to the companies in question and they had ignored me. Although I knew that I wasn’t crazy (at least not in the statutory accounting sort of way) I thought this was a story that needed to be told and I needed confirmation that the information I had found was actually a big deal. I composed my thoughts and facts into a few paragraphs and reached out to several large news organizations, all of whom I respected, were of global consequence, and that I knew would have capable reporters able to understand arcane financial stories. I openly admit avoiding one news organization that steals story ideas from me on a monthly basis…and you know who you are since dozens of you subscribe to this newsletter. I made a deal with myself that whoever contacted me first would be who I would work with since I felt it was a sign of respect for my story and I would offer them that loyalty. After all, while I’m a million different things, above all else I always stick with people who stick with me. Loyalty is an attribute I find in far too few people. Well, a few hours after I’d sent out my emails to the four media outlets, my Blackberry goes off while I’m wandering the fertilizer aisle of my local Home Depot. (I was already daydreaming of my lawn in an effort to forget the parade of blizzards we’ve been getting buried by.) To my surprise, I’d received an email from the absolute, top dog, headcheese, senior managing executive editor of the news outlet and he wants to talk. I immediately email him back that he can call right then and there or wait until the morning (it was 6:30 p.m. already) since I was going to be in the office the next day. Within minutes he writes back “sounds good”. The next day I get a call from the reporter who has been assigned this story. I’m enthused that the boss man has assigned me to the reporter who covered the Enron and AIG stories as well as many insurance stories. He also makes evident a serious understanding of financial accounting, so I figure I’m talking to the perfect guy to cover this for me. I explain my story in decent detail and arrive at the point where I’m faced with a critical decision; at what point do I feel safe telling him the name of the company I’ve focused on. Please understand something, and the something is that the media rips off my work on a constant basis and almost never credits me for the work. I can’t tell you how many times I will send out a newsletter or write a blog post where I receive dozens of emails from people about how they heard someone on TV use almost precise lines of my writings. I actually watched Glenn Beck almost read one of my newsletters on the air one night when he was still back at Headline News. So of course I’m worried that this reporter could just rob my story and I let him know this was my worry. He assures me that he has no intention of that as long as I am willing to go on the record. Well, since I truly don’t have any opinions or judgments to make as part of this story and am simply going to quantify what the company has reported in its annual statement, I have no problem going on any record. If the company didn’t want this information to be out in the public domain, well then they damn sure shouldn’t have put the information in there then. We’ve since spoken several times and I have expanded my hard-core work to two companies with very large problems. I am meeting with the reporter next week to turn over my preliminary work and when the companies file on March 15th I am going to recreate the work again with the new data and the story will appear sometime soon afterward. I also plan on making the excruciating details related to the story available on my blog the moment the story runs publicly, should there be any other humans out there with lives as shallow as mine who care to look. I have to be honest that this was an intensely interesting process and very eye opening as well. It will also serve to add much weight to my argument that our financial institutions are not as secure and rosy as many of them would want you to believe and I’ve got the details to prove it too. Part of me feels kinda bad that the companies are about to get a piano dropped on them and they don’t even know the rope is fraying, but I do take comfort in the fact that I tried reaching out to them with an offer of help which went ignored. By the time my March newsletter rolls around this story should be out in the public and I’ll be able to share things with you that I couldn’t share this month. Finally, it is also striking to consider the idea that it isn’t the insurance companies alone that should bear the only criticism with regard to this story. After I’ve laid out the VERY simple facts, you should ask yourself where everyone else who was supposed to be monitoring this was in this situation. Where were the internal and external auditors who signed off on these numbers? Where were the rating agencies? Where were insurance regulators and the NAIC? Where were the executives and the board of directors who signed off on the validity of these financials? I know we already have the answer and that the answer is nowhere. But that’s the part of this new age we’re living in, where the problems are so large and so vast that it’s difficult to get anyone’s attention when the problem is “only” a few billion dollars. After all, AIG is already into U.S. taxpayers to the tune of over $180 billion and they just let the government know last week that they might need more. One thing I will promise you though. Even if nobody else is watching the money, your friend Mike is ALWAYS watching the money. Stay tuned. YOUR FEBRUARY BRAINTEASER All I will tell you about this month’s brainteaser is that you will likely find it ridiculously easy or impossible. There seems no middle ground on this one. I wish you luck nonetheless. Here you go: “Everything Mr Red owns is red, he lives in a red bungalow and his chairs are red, his tables are red. His ceiling, walls and floor are all red. All of his clothes are red, his shoes are red, even his carpet, television and phone are red. What color are his stairs?” Don’t be weasel and give it a chance before you cave in and peek early, but when you want to view the answer you can do so at the following link: http://www.afs-seminars.com/brainteaser_Feb2010.html Copyright 2010, Michael Gasior. All Rights Reserved AFS Seminars LLC
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February 2010 Newsletter
